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RES Is Moderately Optimistic
RPC, Inc. (NYSE:RES) has begun to realize its journey toward lower carbon-emitting pressure pumping fleets as it recently added another Tier 4 dual fuel pump to its portfolio. In 2021, its positive net additions to the fleet reflect that demand for its ESG-compliant drilling solution is picking up in the market. Against the backdrop of the current energy market recovery, I expect the company's revenues to remain steady.
On the other hand, supply chain constraints, labor scarcity, and the lag in net pricing increase can keep the operating margin under pressure in the near term. RES's healthy balance sheet and the available liquidity may come in handy in dealing with the cash flow crunch in 2021. Given the relative overvaluation versus the peers, I think investors can expect returns to remain subdued in the short term. However, they might want to hold onto the stock in search of higher returns in the medium term.
Understanding The Strategy And Challenges
During Q3, RES operated seven horizontal pressure pumping fleets, which means it added a couple more since the start of the year. By the end of the quarter, it added another Tier 4 dual-fuel fleet. The latest addition is optimized for fuel burn, minimizes emissions, and lowers maintenance costs. The advanced equipment brought in pricing traction, too. Investors may note that many of RES's private operator customers are warming up to the reality of higher energy prices and energy shortages. Energy activities are rising in the US (I will discuss this later), which drives the company's management to take a slightly bullish stance about Q4 and a stronger 2022.
Two key challenges RES faces in the short-to-medium term are seasonality in Q4 and labor shortages. While the weather-related unpredictability and holidays will affect Q4 utilization, the stable energy environment can lead to a flat EBITDA per fleet for RPC. However, labor scarcity, shortages of tubular goods, and cost increases related to third-party logistics can lead to higher costs and lower margins in Q4. The management is likely to pass along the cost increases through higher pricing, but the lag effect may delay achieving a 40%-45% operating margin.
Pricing Improvement Drags
The management does not consider the current environment appropriate for a pricing recovery, although the trend appears to be improving compared to the beginning of 2021. RES will continue to carry a mix of older Tier 2 and the newer Tier 4 ESG-compliant equipment. Since the older equipment typically fetches lower pricing, the pricing improvement will be slow. Also, the bidding activities are still quiet because the overall supply remains constrained due to capex fall and higher decline rate in the US wells, despite the overall fracking activity improvement. To know more about RES in the past, you may read this.
Industry Indicators And Q4 Outlook
It kept pace with the drilled wells count rise in the key US unconventional Basins. In the past year until September 2021, the completed wells count more than doubled (109% up). The drilled but uncompleted wells, on the other hand, declined (39% down). The Permian was the only key shale that saw a production growth (11% up) in the past year. On the other hand, Appalachia and Anadarko saw a steep decrease in production (15% and 13% down, respectively).
The average crude oil production in these shales went down by 5% in the past year, despite the crude oil price resilience in Q4. Since the beginning of Q4 (i.e., October), the US rig count kept the momentum up (11% up). The US frac spread count during this period advanced by 11%, as estimated by Primary Vision. So, the short-term indicators have been stable in Q4 2021.
What Were The Q3 Drivers?
In Q3 2021, Technical Services revenues increased by 20% compared to Q2 2021. Higher activity levels and a marginal increase in net pricing in the larger service lines led to the sequential revenue rise in this segment. The segment's operating margin also improved handsomely (479% up) in Q3.
The recovery in Support Services segment revenue (7% up) was more modest in Q3 versus a quarter ago, while the operating loss lessened during this period. RES's cost of revenues as a percentage of revenues contracted in Q3 due to the pricing improvement and relatively lower operating expense growth.
Cash Flows Fell In Q3
As of September 31, 2021, the company had no debt and positive cash & cash equivalents balance ($81 million). Despite higher revenues in 9M 2021 than a year ago, cash flow from operations dipped significantly (80% down) due to a steep rise in accounts receivable.
The company also has a $100 million revolving credit facility that matures in July 2023. The management revised up its capex forecast for FY2021 and now expects $65 million in capex. This would, however, still be lower than the previous year. A rise in capex can lead to a lower free cash flow.
Linear Regression Based Forecast
Based on a regression equation on the crude oil price, the US rig counts, and RES' reported revenues for the past six years and the previous four-quarter trend, I expect revenues to increase in the next twelve months (or NTM). It can, however, decrease in NTM 2023 but may stabilize in NTM 2024.
Based on the regression model and the forecast revenues, I expect the company's EBITDA to improve sharply in NTM 2022. The recovery can decelerate in 2023, per the model.
Target Price And Relative Valuation
I have calculated the EV using RES's forward EV/EBITDA multiple. Returns potential using the forward multiple (15.4x) is lower (6% upside) compared to returns potential using the sell-side analysts' estimates (9% upside) in the next year. I think the stock has a slightly positive bias in the short term.
RES's forward EV-to-EBITDA multiple contraction versus the adjusted trailing 12-month EV/EBITDA is in line with its peers because its EBITDA stays in line with the peers in the next four quarters. This would typically reflect a similar EV/EBITDA multiple compared to the peers. However, the company's EV/EBITDA multiple is higher than its peers' (PUMP, NR, and LBRT) average of 21.5x. So, the stock is relatively overvalued versus its peers. According to Seeking Alpha, in October, none of the sell-side analysts recommended a "Buy," six recommended a "Neutral," while one recommended a "sell" (including "Very Bearish") on RES.
What's The Take On RES?
Since the start of the year, RES added a few more pumping fleets until Q3, while by the end of the quarter, it added another Tier 4 dual-fuel fleet. The new fleet has a long-term contract. In Q4, a better pricing mix and higher utilization in the stable energy environment can increase the company's topline. So, the stock performed in line with the VanEck Vectors Oil Services ETF (OIH) in the past year.
However, cost rise owing to supply chain constraints and labor scarcity can lead to lower margins in Q4. Although it may pass along the cost increases through higher pricing, the lag effect may delay achieving the operating margin target. So, despite higher revenues, EBITDA per fleet can remain flat. Until now, in 2021, cash flows dropped significantly over the past year. Thankfully, RES has zero debt and a healthy cash balance along with a solid liquidity base. I do not think investors should expect robust returns, but they may hold onto the stock, given the recovery process currently underway.
