- NEX plans to add a Tier 4 dual-fuel frac fleet in Q4 and another in Q1 2022 to enhance efficiency and reduce carbon emission.
- Inflationary costs will keep margin under pressure in the short term.
- In the medium term, lower fleet reactivation and efficiency-related costs will boost its operating margin.
- Negative cash flows and a high debt-to-equity ratio can pullback the upside potential.
NEX Can Take Some Time Before Turning Around
In the past couple of quarters, NexTier Oilfield Solutions' (NEX) customer base strengthened again. As energy activity resumes in the US, the company can better utilize its Tier IV hydraulic fracturing fleets which were added over the Alamo acquisition. With efficient digital fleets, I expect NEX's integrated approach to achieve a higher margin. In the medium term, I also think the fleet reactivation and efficiency-related costs will reduce, which will boost profitability.
However, the typical Q4 slowdown can be more pronounced this year due to the uncertainty over the COVID situation. So, bringing the pricing power back will not be smooth. Although the management promises to turn cash flows positive in 2022, I think the path is riddled with obstacles. The stock is reasonably valued versus its peers. The short-term downsides can keep the stock price bogged down at this level. But, given the strong growth factors, medium-term investors can hold it for an upside.
Technologies And Asset Base Changes
NexTier Oilfield Solutions is one of the largest wireline plug and perf providers through its integrated frac fleet services. The company's pressure-pumping fleets and the NexHub Digital platform in downhole technologies have lowered customers' costs. It has also recently forayed into the Power Solutions fueling business. NEX's Simulfrac fleet business offers a flexible business model, which meets the increased demand for last-mile proppant delivery logistic requirements.
To achieve the strategy, NEX executed rapid fleet deployment during the current recovery as the customer base returned. The other essential part of the strategy lies with the Alamo acquisition in Q2. The acquisition added nine CAT Tier IV hydraulic fracturing fleets to its asset base. So now, more than half of the combined fleet is natural gas-powered and offer a low total cost of ownership. The Alamo acquisition will accelerate the Tier 4 diesel equipment upgrade more efficiently compared to the cost to convert Tier 2 equipment to Tier 4 dual fuel. To know more about the company's strategies, read my previous article.
NEX will have a pricing advantage with its fleet of Tier 4 DGB equipment that will command premium pricing because the industry is transitioning to clean natural gas power and lower-emission equipment. With Tier 4 DGB, customers can realize significant fuel cost savings. However, the TIER 4 products are more expensive. So, to lower the overall cost structure, it will balance its portfolio with some of its conventional diesel fleets. The company's major challenge in Q4 would be the low fleet utilization during the winter. The typical seasonal headwinds from holiday slowdown are already in effect as the US frac spread count, as estimated by Primary Vision, has gone below 250 in the last week of December, after hitting 274 in November.
NEX will deploy a legacy Tier 4 dual-fuel fleet in the US in Q4 and another upgraded Tier 4 dual-fuel fleet through the Alamo operations in Q1 2022. As it left much of the fleet reactivation and efficiency-related costs behind in 2021, I think the company's profitability will improve in 2022. Despite demand and pricing showing further improvement, it plans to keep its fleet count unchanged in 1H 2022. The management expects the Tier 4 dual fuel equipment to stay fully utilized in 2022. Also, its dedicated fleet can see increased acceptance after the lower-cost equipment becomes short in supply.
Industry Drivers And New Technology
In the past year, the drilled wells nearly doubled until November 2021, according to the EIA's latest Drilling Productivity Report. The drilled but uncompleted wells (or DUC), in contrast, have declined by 36% down during the same period. Higher West Texas Intermediate (or WTI crude oil) encouraged the drilled and completed well count hike, which suggests the energy market is turning around.
The company is gearing up to meet the challenges through better technology and various cost reduction measures. In August, it launched the IntelliStim fracturing optimization system, which uses the dedicated wireline fleet and its NexHub Digital Center that help customers implement completion design and maximize well productivity. In 2022, it plans to deploy a fleet of natural gas-powered equipment after completing the fleet upgrading program in 2021. It also plans to expand the Power Solutions business. The management expects to generate robust free cash flow in 2022.
Understanding The Pricing Strategy
NEX has been adjusting to a lower price base following the pricing concessions made since 2018. Since it lowered its cost structure and completed the acquisition (Alamo), it might not need to recoup all the concessions to regain pre-pandemic profitability. It saw inflationary costs in steel, chemicals, sand, trucking, and labor. It passed higher costs through to the customers because it could not absorb higher costs at the current pricing level. Since the management expects the cost pressure to continue, it will set its business plans accordingly in 2022. It is convinced that it can increase the net pricing to reflect higher costs without compromising on the topline too much. Given the low supply and improved demand in the frac market, higher pricing should be well accommodated in 2022.
Explaining The Q3 Drivers
In Q3 2021, NEX's revenues increased by ~35% compared to Q2 2021. Increased wireline, cementing, and coil tubing product lines resulted in revenue growth. The number of active hydraulic fracturing fleets increased from 18 to 22 from Q2 to Q3, including a Simulfrac fleet formation. This means the combined number of fleets (NexTier and Alamo) went up to 31, including 29 domestically. It also makes NEX one of the US's largest natural gas-powered, low-cost, low-carbon frac services providers.
In Q3, revenues went up by 36% in the Completion Service segment, while the adjusted gross profit increased by 127% from a quarter earlier. In the Well Construction and Intervention Services segment, revenues and adjusted gross profit increased by 16% and 5%, respectively, from Q2 to Q3. Despite the COVID and logistics disruption-related challenges, it achieved $18 million to $20 million of adjusted EBITDA target in September, which helped the EBITDA grow.
Cash Flows And Liquidity
In 9M 2021, NexTier Oilfield's cash flow from operations (or CFO) turned negative compared to a positive CFO a year ago. A decrease in wireline and pump down services pricing, an increase in commodity prices, fleet re-deployment costs, and input cost inflation led to the CFO fall. As a result, the company's free cash flow (CFO less capex) turned significantly negative in 9M 2021.
However, in 2022, its capex will reduce significantly after it already funded the investment required to convert a large portion of the fleet in 2021. It plans to turn positive free cash flow beginning 2022. The company's liquidity totaled $290 million as of September 30, 2021. Its debt-to-equity ratio (0.71x) is significantly higher than its competitors' (BOOM, HLX, and DRQ) average.
Linear Regression Based Forecast
Based on a regression equation between the key industry indicators and NEX's reported revenues, I expect revenues to increase sharply, particularly in the next 12-months (or NTM). The topline growth can moderate in the following year.
Based on a simple regression model using the average forecast revenues, I expect the company's EBITDA to improve sharply in the next two years.
Target Price And Relative Valuation
I have calculated the EV using the forward multiple. Returns potential (106% upside) using the forward EV/EBITDA multiple (15.9x) is higher than Wall Street's sell-side analyst expectations (68% upside) from the stock.
NEX's forward EV-to-EBITDA multiple contraction versus the adjusted trailing 12-month EV/EBITDA is steeper than its peers, which typically reflects a higher EV/EBITDA multiple than the peers. The stock's EV/EBITDA multiple (~140x) is higher than its peers' (BOOM, HLX, and DRQ) average of 40x. So, the stock, I think, is reasonably valued at the current level.
What's The Take On NEX?
Source: Seeking Alpha
Since the energy activity recovered in the US, NEX executed rapid fleet deployment as its customer base strengthened again. The Alamo acquisition earlier in the year added nine CAT Tier IV hydraulic fracturing fleets to its asset base and also accelerated the Tier 4 diesel equipment upgrade more efficiently. The company's Simulfrac fleet business and NexHub Digital platform offer an integrated approach, which is conducive to achieving a higher margin.
However, the Tier 4 products are more expensive with regard to additional horsepower deployment. Also, given the level of excess frac equipment in the market, it adjusted pricing at a lower level, which affected its profitability. The inflationary costs in steel, chemicals, sand, trucking, and labor are likely to continue in the short term. Although the management is quite confident of bringing the pricing power back, it will not be easy. NEX also deals in negative cash flows and a leveraged balance sheet. So, the stock underperformed the VanEck Vectors Oil Services ETF (OIH) in the past year. I expect the stock to remain steady at this level, which should encourage the investors to hold it for an upside in the medium to long term.
This article was written by
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