Following the energy market recovery, Weatherford International (NASDAQ:WFRD) has been strengthened by market share gains and price hikes. Along with the North American drilling and shale production growth, its products and services and contract awards in the Middle East, Latin America, Asia, and Sub-Saharan Africa will likely recover in 2022. Along with margin expansion, I think it will also turn free cash flow positive in 2022.
However, the supply chain bottlenecks and a tight labor market have constrained growth. Plus, it has high leverage. But, with a robust cash balance, managing debt should not be critical in the medium term. The stock is reasonably valued versus its peers at this level. I think investors want to hold the stock for a healthy medium-term return potential.
Weatherford International's strategic objectives have shifted from high volume, low margin services to high-margin offerings. I discussed this in greater detail in my previous article. While it continues to provide pressure drilling, cementation products, tubular running services, and fishing, it gears to do more after refining its portfolio, focusing on specialty services.
Demand rises for WFRD's integrated MPD (managed pressure drilling) and TRS (tubular running services). In North America, its outlook has been strengthened by market share gains and price hikes following crude oil price rise and increased upstream capex. There has been a significant increase in drilling activity in the US and associated services. Year-to-date, the US active frac spread count went up by 19%, according to Primary Vision's estimates. From December 2021 to March 2022, the drilled and completed well count was higher (17% and 4% up, respectively), while the drilled but uncompleted (or DUC) wells declined by 9%. Many shales saw higher rig count additions during this period, which will help augment WFRD's financial results.
In the coming quarters, we will likely see the Middle East and Latin America leading the growth in energy activity in WFRD's operations. Latin America, in particular, will become a focus for the company as it goes through structural changes. In Q1 2022, revenues from this geography increased by 29% year-over-year. Asia and Sub-Saharan Africa can see increased demand and higher contract awards. These two markets are likely to see a strong recovery following the ebb of the demand drop in COVID.
In Q2 2022, the management expects revenues to increase by mid to high single-digits compared to Q1 2022. The adjusted EBITDA margins can improve by 50 basis points versus the Q1-level (16%). Segment-wise, the WCC (Well Construction and Completions) and P&I (Production and Intervention) can deliver high single-digit growth, followed by D&E or Drilling & Evaluation (mid-single-digits growth).
While there could be some negative impacts from the Ukraine-Russia conflict, the company estimates that only 1% of its revenues are generated in Ukraine. Also, robust demand growth in other international regions following the crude oil price hike and increasing capital investment led by an elevated focus on energy security and supply should boost WFRD's topline in Q2. The positive factors can also lead to a positive free cash flow in 2022.
In Q1 2022, higher demand for cementation products and activity in North America resulted in the WCC segment revenue remaining steady compared to Q4 2021. On the other hand, higher logistics costs and supply chain challenges adversely impacted the delivery schedule for products in North America. This caused the Production and Intervention segment revenues to decrease by 4% quarter-over-quarter in Q1. The adjusted EBITDA margin improved by 100 basis points sequentially in Q1 2022.
One of WFRD's key performers has been managed pressure drilling, or MPD. Recently, it has formed a collaboration in rotating control devices and the annual isolation device in its subsea services. It will integrate MPD into a single automated connection for all drilling operations and help increase production while lowering well construction costs. The integrated service has been deployed on the Maersk Viking ultra-deepwater drillship.
On March 31, 2022, WFRD had a debt of $2.4 billion, while its cash & equivalents were $841 million. Despite higher revenues, its cash flow from operations turned negative in Q1 2022 compared to a year ago. The energy up-cycle increased its working capital requirements in Q1. On top of that, capex increased, leading to a significant drop in free cash flows (-$84 million) compared to a positive FCF a year ago. The company's debt-to-equity (or leverage) ratio of 5.7x remained higher than its peers (BKR, NOV, NBR) due to its high debt level and low equity base.
Weatherford is trading at an EV-to-adjusted EBITDA multiple of 6.9x. Its forward EV-to-EBITDA multiple contraction is less steep than its peers' average because sell-side analysts expect its EBITDA to increase less sharply than the peers in the next four quarters. This typically results in a lower EV/EBITDA multiple. The stock's EV/EBITDA multiple is lower than its peers' (BKR, NOV, and NBR) average of 16.3x. So, the stock is reasonably valued at the current level.
Two sell-side analysts rated WFRD a "buy" in March, while none of the analysts rated it a "hold." The consensus target price is $51.3, which yields ~53% returns at the current price.
According to Seeking Alpha's Quant Rating, the stock has a "hold" rating. While the ratings are moderate on momentum and valuation, they are poor on growth, profitability, and revisions.
Over the past year, Weatherford benefited immensely from the energy industry's rapid recovery and its strategic repositioning. Despite some slackness in the Well Construction and Completions and Production and Intervention segments, the company's emphasis on margin expansion paid off. The demand for its integrated MPD and TRS services is rising in the US. Internationally, the Middle East and Latin America will lead the charge in 2022. As a result of the positive momentum, the stock outperformed the VanEck Vectors Oil Services ETF (OIH) in the past year.
Given the relative valuation, you might hold the stock for a relatively long period for a steady return. However, a few deficiencies are also visible. Its debt-to-equity is too high compared to its peers in the industry. Negative cash flows in Q1 mean the initiatives to deleverage will not be easy. Nonetheless, the company boasts a robust cash balance, which reduces the risks associated with a highly leveraged balance sheet and prompts investors to hold the stock.
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