When Dimensional Fund Advisors is one of your top 10 shareholders, it’s fair to say your company is a value stock. Hunting PLC (LSE:HTG, Financial) is an oil and gas equipment and service provider that, like others in its industry, suffered in the downturn in oil markets over the last several years. Whilst listed in London, Hunting is primarily exposed to U.S. onshore oil and gas production, where production activity closely tracks the oil price as it is relatively easy to press the stop and start button compared to offshore production.
Onshore oil production had, until recently, built up a reputation of chasing volume over value, squeezing margins all along the supply chain. This has meant that for a long time, until the recent crude oil price rally, investors would have done better to steer clear of investing in the oil patch. Even before the pandemic, Hunting was issuing profit warnings in late 2019 thanks weakening performance in U.S. shale.
Activity is picking up now as crude oil prices have rallied hard over the last year. Hunting’s 2020 financial year, like many companies, was probably a one-off as the perfect storm of an OPEC price war and the pandemic killed the oil market. The company, impressively, managed to keep its dividend when many peers took a massive axe to theirs.
As Hunting CEO Jim Johnson commented at the end of June in a trading update:
"With the oil price firmly above $70 per barrel, along with the production discipline seen within the OPEC group and the improving global economic outlook, management expect a gradual improvement in hydrocarbon demand in the short to medium term. In the period, the Group has moved from a negative EBITDA result in Q1 2021 to a positive EBITDA result in Q2 2021, driven by an improving market in the US onshore. While there has been an increasing onshore rig count across North America, operators continue to demonstrate strong capital discipline which has led to drilling expenditures remaining subdued throughout H1 2021. Given the stronger oil price environment, we believe that as client cash flows improve capital expenditures will also increase, leading to robust demand for the Group's products and services supported by a significantly improved outlook for the industry for 2022 and beyond.
Pricing within the oilfield services sector was deflationary in H1 2021 across all product lines, as too many goods and services pursued an industry hampered by persistently low rig counts. However, at current oil prices management anticipate an improvement in margins and pricing, supported by increased input prices, improving demand and a tighter labour market, especially in North America.
Within Hunting Titan and the Group's US onshore-focused business units the trading environment has strengthened through the second quarter, with revenue increasing as the onshore rig count improved. Hunting's EMEA and Asia Pacific operating segments continue to experience challenging trading conditions given the ongoing impact of COVID-19, with OPEC production constraints also continuing to depress drilling activity across the Middle East, further exacerbating the recovery within these segments."
Since then, OPEC has eased its constraints, which will likely help Hunting’s Middle East business, although it has caused the oil price to dip over the last several days.
Even if the oil price falls a bit further, Hunting is in a good place. It has a slight net cash position and a strong Altman Z-Score of 4. In 2020, the company took the opportunity to push through a restructuring, which it estimates will produce annualized cost savings of $86 million. This is a significant figure given the market capitalization of the company is $486 million as of this writing.
In 2020, the offshore division managed to grow revenue 57% thanks to previous increased investment in this division. Offshore oil and gas spending is more stable than the U.S. onshore sector, giving Hunting lower volatility in earnings going forward. This growth was driven by a couple of recent acquisitions: U.K. company Enpro Subsea was purchased last year and RTI Energy Systems in mid-2019.
Hunting is a Titan in perforating systems
Hunting’s best-known division is Titan, which has perforating guns that onshore drillers use to shoot holes in oil well casings to allow oil to flow into the pipe. Titan is the petroleum industry’s manufacturing leader in perforating systems, wireline selective firing systems, cased hole logging instruments, nuclear detectors, energetics and associated wireline hardware and accessories. It holds dozens of patents.
Ultimately, however, the Titan division is dependent on the rig count, which is dependent on the oil price. In the medium term, oil prices are likely to stay elevated as vehicle miles driven stay high as consumers avoid public transportation. On the supply side, environmental, social and corporate governance concerns mean funding for petroleum projects is getting tighter.
In 2019, Titan’s operating margin was close to 20%, which gives it room to cut prices to defend market share. According to a report by Barclays, Titan has had around 33% market share over the last several years, but this dipped below 30% in 2019. When rig count picks up, the equipment market often tightens, giving Hunting Titan the opportunity to raise margins and capture market share thanks to its large and widely distributed U.S. manufacturing facilities.
The current U.S. rig count is at 484 according to Baker Hughes (BKR, Financial), and that’s up by 231 since a year ago.
But Hunting’s move to balance out its business is one I like, as historically, the stock traded like an exploratio and production company. Now, while still being correlated to the oil price, a more balanced portfolio of businesses helps reduce the dependence on the rig count. Investors can start to look at Hunting as a manufacturer of premium equipment, rather than a drilling activity proxy. That drilling correlation should be reduced even more since Hunting exited the commoditized drilling tools business and has invested in well analytics and big data company Well Data Labs, moving its portfolio even further up the value chain.
Energy Transition? No. Pursuing diversification from oil and gas sales? Yes.
Hunting’s CEO is an oil man through and through. His stated strategy is to stick to his knitting in the markets Hunting knows best. I like this strategy. Where the company is also differentiated from other oil and gas equipment and service providers is through its Advanced Manufacturing division, which serves medical, aviation and space divisions and has Elon Musk’s SpaceX as a customer.
Valuation
The stock trades at a price-book ratio of 0.5 compared to its five-year average of 0.9. Its price-to-cash flow is 8.4 versus its five-year average of 23.6 and its dividend yield is 3.5% compared to the five-year average of 1.4%. Hunting should not trade like a distressed commoditized oil and gas equipment and services company because its products are generally higher quality thanks to its expertise in precision engineering. Additionally, its increased diversification across the many different areas in energy production have reduced its risk levels.
Hunting will report half-year results on Aug. 26.
