Liberty Oilfield Services: Cash Flow And Margin Concerns Offset Demand Recovery
Summary
- LBRT's pricing for its services is likely to improve in the short term, although it expects utilization to remain challenging.
- I think the company's revenue will increase in Q3, while the pressure on the margin will be limited as it incorporated the compensation hike ahead of its time.
- The company’s low leverage is an advantage over many of its peers.
- I do not think the stock has many upsides in the near term.
LBRT Clears Its Way Up
In 2021, energy demand has improved while the frac equipment supply remains unchanged, leaving room for gradual frac pricing recovery. With this tailwind, Liberty Oilfield Services (NYSE:LBRT) will benefit from the early upcycles as it steers more works to fully dedicated fleets and fewer inter-basin fleet movements. In the medium-to-long term, the acquisition of OneStim from Schlumberger (SLB) will bolden its effort to convert the frac fleet to electric and offer a fully electrified solution for the customers.
Nonetheless, supply chain and wage inflation due to labor shortage remain the company’s primary challenges in the short term. Although LBRT's balance sheet reflects low leverage, the cash flow concerns can spell trouble if it persists for long. I think the Wall Street analysts are overestimating the returns from the stock. Investors might want to hold the stock for now before expecting a steady return in the medium to long term.
Analyzing The Strategies
Post COVID-19, the energy environment has been fascinating to watch. After the frac fleets were rapidly downsized in the last downturn in 2020, the demand side shows steady improvement in 2021. The drilled-but-uncompleted (or DUC) wells have been reducing, while the drilling and completion activities are rising. Essentially, such a situation paves the way for a consistent increase in the pricing and frackers' margin. In January, Liberty acquired Schlumberger's OneStim, consisting of the US and Canada onshore hydraulic fracturing business. Such a step signals the management's confidence in the revival of the North American onshore business after the steep activity drop of 2020.
The other key aspect of LBRT's strategy is its focus on providing electric fracking services. Recently, it field-tested the digiFrac electric frac pump in the Delaware Basin. digiFrac now accounts for ~10% of its pumping capacity. After acquiring the electric frac side from the OneStim, the company now plans to provide a fully electrified solution for the customers. Plus, digiFrac will also fulfill its ESG objectives and help lessen emissions by at least 20%, estimates the company. According to Primary Vision, the frac spread count started at 133 at the start of 2021 but has nearly doubled since then. To know more about the company's strategies, read my previous article here.
Looking At The Industry And Outlook
The crude oil price recovered strongly in Q2, although the growth rate has slackened since then. The US rig count, which recovered by 12% in Q2, is stabilizing in Q3. The number of drilled-but-uncompleted (or DUC) have been coming down in 2021 while the drilled and completed well counts are strengthening fast in the key unconventional resource shales. Despite the upstream budget constraint, the energy activity rises captured LBRT's management attention.
In Q3, LBRT benefits from early upcycles as it steers more works to fully dedicated fleets and fewer inter-basin fleet movements. The company believes upstream companies' free cash flow generation recovery will increase the completion service demand. This will slowly lead to a continued modest rise in service prices. The other constraints facing the US have been the lack of labor market supply and supply chain issues. Over the past few months, these have led to a rise in inflation and wage growth. So, we see many service providers engage in pricing discussions with their upstream clients to offset the cost hike.
What Are LBRT'S Recent Drivers?
LBRT's financial performance was much improved in Q2 2021. From Q1 to Q2, its revenues went up by 5%. If we exclude the revenue loss due to the Canadian spring break up, revenues would have been higher by 9%. The primary reasons for the rise were the increased activity across all US basins, despite low utilization, the supply chain challenges, and the labor shortage issues, as I discussed above.
The company managed its costs so well that its adjusted EBITDA increased to $37 million in Q2 compared to $32 million in Q1. Investors may note that the company restored field personnel variable compensation one quarter ahead of time due to the labor shortage in the market. Excluding that, the Q2 adjusted EBITDA would have been $45 million. Liberty has been subject to staffing issues and industry supply chain challenges, including trucking shortages. Many energy operators have been transitioning from completing DUCs to new well construction, leading to difficulties in calendar coordination and above-normal inter-basin fleet movements. While this led to higher costs, LBRT is set to benefit from a higher activity level in the coming quarters.
Understanding The ROCE
In Q2 2021, its return on capital employed (or ROCE) (ratio of pre-tax net income to average capital employed) stayed negative (-18%) and was a slight deterioration compared to FY2020. This marked a steep fall from the 10% ROCE recorded in FY2019. Because there has been no change in the company's debt level since the start of 2021, the lower ROCE shows a steeper net loss. So, despite the top line and operating level performance improvement, the bottom line remains a concern for LBRT.
Cash Flows And Debt
LBRT's cash flow from operations (or CFO) depleted by 63% in 1H 2021 compared to a year earlier due to higher working capital requirements. Although it reduced capex, it did not affect the free cash flow (or FCF). So, its FCF deteriorated significantly in the past year, turning negative in 1H 2021.
As of June 30, 2021, LBRT's liquidity amounted to $277 million. With the available liquidity (cash balance plus credit facility), debt repayment looks comfortable. The company's debt-to-equity (0.09x) is significantly lower than many of its peers in the fracking services industry.
Linear Regression Based Revenue Forecast
I have observed a regression equation based on the historical relationship among the crude oil price, rig count, and LBRT's reported revenues for the past five years and the past four quarters. I think that the longer trend factor has more influential importance on the trend. So, I expect its revenues to increase sharply in the next 12 months (or NTM 2022). It will stabilize in the following two years.
Based on the same regression variables, I expect the company's EBITDA to increase significantly in NTM 2022. In the following couple of years, the model suggests the EBITDA growth rate will decelerate.
What's The Target Price?
I have calculated the EV using FET's forward EV/Revenue multiple (because EBITDA is expected to remain negative, the EV/EBITDA multiple does not produce any meaningful result.) As a result, the returns potential using the forward EV/Revenue multiple (0.96x) is lower (4% downside) compared to the sell-side analysts' expected returns (~36% upside) from the stock.
According to Seeking Alpha's Quant Rating, LBRT currently receives a "Neutral" rating. While the rating is moderately high on the growth criteria, they are low on momentum, profitability, revisions, and value.
What's The Take On LBRT?
As demand improves and frac equipment supply remains unchanged, I see a compelling signal that the frac pricing recovery is underway and gaining momentum in 2021. The number of drilled-but-uncompleted (or DUC) have been coming down in 2021 while the drilled and completed well counts are strengthening fast in the key unconventional resource shales. So, LBRT's stock price outperformed the VanEck Vectors Oil Services ETF (OIH) in the past year. After gaining the electric frac operations through the OneStim acquisition in early 2021, LBRT now plans to provide a fully electrified solution for the customers.
However, the company may hit some road bumps due to low utilization, supply chain challenges, and labor shortage issues. I think the margin pressure will dissipate in the near term, and its operating margin will get a boost due to the topline pull. With low leverage and a robust balance sheet, the balance sheet enjoys a significant advantage compared to some leveraged oilfield services players. I think the investors might want to hold back a little in the near-to-medium term before lapping up the stock.
This article was written by
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