DEP Update: We still have a few open spots for our golf outing on November 10th at the Woodlands Country Club (DEP clients only) – let us know if you are interested. We’ll be in Houston this week due to earnings season/World Series with plans to return to Midland again the week of November 1st for the Executive Oil Conference; DFW on November 10th/11th, and then DFW/East Texas the week of November 15th. Finally, we’ll begin sending out preliminary information on the THRIVE 2022 Energy Conference sometime this week as our agenda is nearing completion.
ProFrac / FTSI Deal. On Friday FTSI announced it will be acquired by ProFrac Services for $408M in cash. This transaction, if consummated, will result in a combined company which, we believe, is actively marketing about 28 fleets. If our tallies are correct, we have Pro Frac at 15 fleets and FTSI at 13 fleets. The combined active fleets are located in Permian (12), Marcellus (5), Eagle Ford (4), East Texas/Haynesville (5) with the balance elsewhere. The biggest region benefitting from the consolidation in this deal, we believe, is the Permian where FTSI had 8 active crews while Pro Frac had four. Headline valuation metrics as follows: (1) 16.2x annualized Q3 EBITDA; (2) 7.3x annualized adjusted Q3 EBITDA; and (3) $31M per active FTSI fleet. The price per share is a 14% premium relative to FTSI’s 60-day volume-weighted average closing price. On the surface the price screens high, but there are a few necessary things to consider. First, FTSI is building a new Tier 4 DGB fleet which was guided to cost $26M. Second, FTSI owns its own internal fluid end manufacturing operation. Hard to place a value on the manufacturing operation and not sure how much that matters to ProFrac since it too is vertically integrated. Third, FTSI owns a significant inventory of stacked equipment which could presumably be used to minimize future capex. Again, tough to place a value on idle equipment, but we surmise the stacked fleet represents equipment for cannibalization should the combined entity seek to minimize capex on legacy equipment. This matters.
With respect to the newbuild fleet, if one simply adjusts the $408M purchase price by the Tier 4 DGB capex commitment, the price per active fleet drops to $29M. Moreover, if one gives an estimated EBITDA contribution for the Tier 4 DGB fleet, which is probably in the $12M annualized range, the adjusted multiple would migrate closer to 6.0x. The big picture, though, is the set-up for 2022 is much improved as all frac contacts are reporting efforts to raise rates, in many cases with the increases set to apply in early 2022, thus using Q3 results for valuation purposes is far too penal.
As for our thoughts on the deal – mixed emotions. The challenge with M&A is we lose clients, so a totally self-serving complaint as FTSI has been a supporter of DEP. We wish them well and appreciate their support. But for the broader U.S. frac market, this deal is a resounding positive as we have been preaching the need for consolidation and deals are now unfolding. First, we saw LBRT/SLB last year. Then, we witnessed NEX and Alamo during the summer and this week we see ProFrac and FTSI. Presumably, more deals will materialize in 2022 as we have had numerous small private players tell us they want out – the question is will they find a willing buyer. For those who have newer equipment (i.e., emission friendly) and have reasonable expectations, the answer is likely yes.
Takeaways From the Permian Basin Oil Show. Times are seemingly good based on event attendance and the number of evening parties throughout the Midland/Odessa area. Somewhat surprising was the sheer volume of corporate jets parked at the Signature FOB this week – not quite Davos or Aspen, but enough to warrant a photo and enough to suggest there are those willing to spend a bit more these days. Not surprising, however, is the tremendous support for Brandon as displayed by numerous signs at several of the booths. As for the mood, cautious optimism with more struggles on labor surfacing in all our discussions. Namely, employee poaching is on the rise.
We visited with one frac company who acknowledged it recently staffed two fleets via taking crews from larger peers. Meanwhile, another frac contact claimed victim status, reporting as much as 10% of its crews were poached recently. For a new company launching a business, we appreciate the need to recruit away experienced talent. For established companies, the poaching strategy is ill-advised as higher labor costs often precede net pricing improvements. Poaching, of course, is not just confined to frac. We toured a sand operation this week that is now reacting to wage increases implemented at nearby mining facilities. Mining employees were approached by a competing facility leading to the incumbent employer’s evaluation of an appropriate retention countermeasure.
In terms of new equipment, two new electric frac designs were on display at the oil show, as expected. The first solution is the Thor design from EnQuest Energy Solutions. The second design was displayed by Keystone Synergy. The first employs a 5,000hp power end design while the other employs a smaller 2,500hp power end design. Both, of course, are being introduced to help improve emissions. The key for both units is to get field trials underway. Emission-friendly equipment was not limited to frac as Texas Wireline showcased its new electric wireline unit called EcoTrux. The unit at the show will go to a new wireline start-up.
Our Permian trip included meetings with two new frac start-ups and one private well service contact. One frac player will commence frac operations this quarter while the other commenced frac operations a few weeks ago. One is targeting HZ work while the other is focused on vertical projects. Both see strong demand and customer interest. Both believe they can grow in 2022. So, while we are upbeat about the ProFrac/FTSI deal, the rise in start-ups, albeit still small, necessitates bigger deals by others. Lastly, our well service contact reports a leading E&P will soon pick up as many as 20 additional well service rigs. Benefit of the well service job is it is often an expense item thus the E&P can address production without having to spend capex dollars.
U.S. Land Rig Count. BKR land rig count down 2 rigs w/w to 527.
Siren Energy. The push for more emission-friendly equipment is real and this means new fuel/power solutions will be required. A new entrant to the CNG market, Siren Energy, will commence operations later this quarter. Earlier this week, we toured the company’s first CNG compression facility located in Orla, Texas and learned about the initial fueling line which could expand in size/scope. This, we believe, will be the first of multiple Siren compression stations as growth in Tier 4 dual fuel and electric frac should presumably drive demand for CNG higher. Several factors make the Siren business model unique. First, the company will transport the CNG using trailer design purportedly capable of transporting 540 mmbtu CNG (~3,600 DGE) at 4,000 psi, an amount Siren contends is as much as 30% more volume than other CNG delivery solutions. These trailers are built by CATEC Gases. Second, this is a female-owned and operated business, a potentially important attribute for larger companies who focus on D&I as part of the procurement process.
Q3 Earnings Thoughts:
A few quick highlights. This week we are attempting to avoid much of the normal q/q elevator analysis but instead trying to focus on higher level observations. Also, apologies to the handful of reporting companies we missed. We’ll try to comb through those transcripts this week and opine on them next week.
You Don’t Quit A Job Until You Find A Job. An appropriate quote from HAL’s CEO in describing the current market. The comment, in our estimation, was made in reference to HAL leaving lower price customers and moving to those who would provide better pricing terms. HAL’s messaging of rising demand and upgrading customers was not a singular view as PDS’ CEO stated it turned down incremental rig deployments due to low prices. Not a shocker, but the OFS sector continues to see rising demand with bidding activity underway. Specifically, PDS noted it is running 45 rigs in the U.S. today but has inquiries for 200 rig opportunities. To be clear, PDS is not calling for a 200-rig count increase as it believes some inquiries are customers simply looking to test the market on price. However, the level of inquiries is sufficiently robust that smart management teams will withhold capacity as pricing is likely moving higher. Remember, in down markets the service industry shoots itself in order to maintain market share and keep equipment working – a herd mentality, in our view. Conversely, when the cycle is hot, E&P companies all call for equipment at the same time, effectively bidding up service costs. Again, a sign of herd mentality.
HAL: We’ll focus largely on NAM operations. NAM revenue was up 3% q/q as Hurricane Ida served as a modest headwind. Good wins in recent months as HAL has its new Zeus pump working for CHK in the Marcellus along with a recent win with Aethon in the Haynesville with a third, we believe, with a Permian E&P. We also believe HAL has a similar set up in the Permian. Net pricing gains reported in multiple segments which gives HAL reason to see an improvement in margins going forward. Near-term outlook is reasonable with HAL calling for mid-single digit revenue growth in the C&P segment with margins up 50bps q/q. In the Drilling and Evaluation segment, revenue is expected to be up 5-7% q/q with margins up 150-200bps. While the DEP team leans heavily U.S. land, HAL’s international outlook is quite promising. Meanwhile, balance sheet metrics remain comfortable as HAL generated FCF of $469M in Q3, cash stands at $2.6B with $9.1B of debt.
HAL noted a moderation in completion activity in Q3 as customers shifted their focus from completions to drilling. This stabilization is frankly not a surprise as we, and a few others, have been talking about this all quarter. BTW – FTSI’s Q3 pre-release on Friday showed a q/q decline in revenue (Q3 will be $88-$93M vs. $100M in Q2), also consistent with HAL’s comments. That said, the outlook is bright, at least for drilling near-term as HAL contends rigs are needed to replenish DUC inventories which have been depleted – makes sense and seems to be confirmed by PDS commentary about inquiries for ~200 rigs. Looking ahead, HAL sees E&P customer spending in NAM up about 20% in 2022. We’ll take the over, but let’s play ball and accept a 20% number. With service costs likely up over 10%, this would imply activity would rise 10% as well. The U.S. rig count, per BKR, is 527 rigs as of Friday. The average U.S. rig count in 2021 YTD is roughly 440 rigs. Let’s assume not one additional rig goes to work, which is silly given the PDS commentary, then the implication is the 2021 rig count would average closer to ~460 rigs. Holding that ~527 constant in 2022 would then imply a ~15% y/y improvement vs. the YTD average (527 vs. 460). With service costs inflecting higher, there’s no way, in our humble opinion, spending is up only 20% y/y. That said, we fully understand and appreciate the need for guidance to be measured at this point.
One final thing of note from HAL’s conference call. Management alluded to frac utilization at 85%. Here’s our quick take. We believe HAL sees the U.S. frac fleet that is capable of working to be in the 260 range whereas actual working fleets are somewhere in the 220 range. That’s about 85%. Here’s our view. First, we continue to see active fleets around 230. Effective fleets, or working, is probably in the 210-220 range. Case in point, FTSI’s preliminary Q3 results show 13 active fleets with effective fleets at 10.8. We point this out as again, as there are those who claim the U.S. working fleet is over 260 and grew during Q3. Some companies reference those weekly numbers, which could be a mistake, in our view.
PDS: Conference call commentary focused on positive outlook for rig activity in all markets. Precision’s U.S. rig count at 45 rigs today with an expectation for rig count to exit above 50 rigs by year-end. Roughly a 10-12 % gain. Simple math and extrapolation to the entire U.S. fleet would imply the BKR land rig count would move from 527 this past Friday into the 575 vicinity by year-end. Let’s assume we exit at 575 and stay there all year in 2022. That would suggest a y/y improvement in U.S. drilling in the range of 25% (575 vs. 460). Again, to our point in the HAL commentary, such an improvement in activity would suggest spending must be up handsomely next year.
In Canada, PDS is running 61 rigs, a 21% improvement over Q1 levels and an increase from the 51-rig average in Q3. The rise relative to Q1 is notable as Q1 is often the strongest quarter for industry activity levels. Looking ahead, PDS sees 2022 activity exceeding 2018 levels. In the Middle East, PDS secured contract extensions and sees tenders resulting in incremental activity gains in Kuwait.
Adjusted EBITDA was $59M in Q3. Interesting PDS tidbit. Company claims a $1,000/day improvement on its 112 total working rigs (globally) distills into an incremental $40M of annual EBITDA. Normalized margins, meanwhile, guided to improve $1,500-$2,000/day q/q in both the U.S. and Canada. The gains are poised to rise in the coming quarters given company efforts to raise rates. Point is the leverage we have historically witnessed in the land drilling sector is poised to repeat itself. For PDS, which has made remarkable strides reducing debt, the opportunity to further improve the balance sheet in 2022 seems real. As a reminder, the company has reduced debt by over $600M in recent years and the Q4 reduction should range somewhere near $40-$60M. Moreover, as results improve the company will have greater wherewithal to further its investments in ESG power solutions, an area highlighted during the Q3 call. Ditto, new technology which is witnessing impressive growth.
BOOM: Q3 Revs= $67.2M +3% q/q; Adjusted EBITDA $5.8MM -$1.7 M q/q. Company’s Q4 outlook (Revs=$68-74M and Adjusted EBITDA ~$5-6M). Capital expenditures $2-4M. Results struggled as supply chain posed a number of problems while continued litigation expenses (protecting IP), input cost inflation, and a challenging NAM pricing environment also weighed on margins. The company does expect its recent +5% pricing improvement measure (End of November) to result in some gains. The original price increase announced in the first quarter of 2021 did not get support from the industry. BOOM contends its integrated well perforating system is well regarded and should continue gaining traction as activity continues to ramp up into 2022.
BKR: Consolidated revs = $5.1B, down 1% q/q with Adjusted EBITDA = $664M, +9% q/q. Orders in Q3 totaled $5.4B, +6% q/q. Lots of meat in the earnings release/transcript, but we’ll keep our focus is on BKR’s core OFSE businesses. The Oilfield Service segment reported revenue of $2.4B, +3% q/q – driven by NAM land, LAM and the Middle East. Operating income was $190M or a 7.8% margin. Q4 revenues guided up mid-single digits with operating margins expected to approach double-digits. Management noted the OFS international business should see double-digit revenue growth in 2022. Within Oilfield Equipment, revenue totaled $603M with new orders totaling $724M. Operating income came in at $14M. Revenue in Q4 is expected to decline with margins remaining in the low-single digits. For 2022, the company sees a modest recovery in offshore activity. Revenue will be down y/y due to the removal of SDS from consolidated OFE, but margins should be up.
Management sees a multi-year cycle developing for the OFSE segment which will see longer-term investment into the core OPEC+ countries. During Q3 international markets such as Southeast Asia witnessed the strongest growth in rig count, followed by Latin America and the North Sea. Russia and the Middle East were slower, a function of the measured approach, but these markets should see better growth in 2022. BKR remains committed to achieving OFS EBITDA margins over 20% in the medium-term – they were ~15% in Q3. This will come via business optimization, higher activity and pricing.
We’ll cease with the elevator analysis and end on the bigger picture. BKR authorized a $2B share repurchase program in July. Pretty strong statement on management’s outlook. The company’s balance sheet is strong with cash = $3.9M and total debt = $6.8B. As noted earlier, there is no shortage of wins in the company’s prepared earnings release while Q3 commentary is largely upbeat as transitory issues which impacted recent results (i.e., inflationary cost pressures, storms, etc.) are behind us and/or are being addressed via price recovery.
End Times? People have long searched for signs of the end times. The DEP research team found them today. Yes, it’s a crazy world right now, but just when we think it can’t get much worse, it does. Today we went to a bar for lunch after church – it’s ok because the first miracle was converting water to wine, so we think we’re good. And, say what you will about politics and the NFL, but we still like to watch football on Sunday, thus the bar. Unfortunately, instead of football, the bar was showing World Chase Tag. Yes, that’s right. Tag. We thought watching corn hole on TV was bad but watching a bunch of grown dudes running around playing tag is about the worst we’ve seen. Therefore, the end is near. And, go figure there are actually sponsors for tag….perhaps DEP should tap into that marketing budget while there is still time?
As always, this research note is not investment advice. Never has been. Never will be. It’s simply our industry observations.