Patterson-UTI Energy (PTEN, Financial), which operates in the onshore contract drilling segment in the U.S. and Canada, has declined by 26% in the last six months. This is not a surprise as all stocks related to the oil and gas sector have declined.
Amid the carnage, there are few attractive investment opportunities, and there are few names that investors need to keep in the investment radar. Patterson-UTI Energy belongs to the latter category and investors still need to wait before considering exposure to the stock. This article discusses the factors for this view and the key positives from a long-term perspective.
Coming first to the reasons to suggest staying on the sidelines, the following factors back that view.
For October 2015, Patterson-UTI had 92 drilling rigs operating in the U.S. and four rigs in Canada. For November 2015, the company had an average of 91 drilling rigs operating in the U.S. and four rigs in Canada. Further, for December 2015, the company had an average of 88 drilling rigs operating in the U.S. and three rigs in Canada. It is clear from 4Q15 data that the number of operating rigs is declining and the decline in December 2015 was more meaningful. With oil sliding in January 2016, this negative trend seems likely to continue.
Most oil and gas companies will report their 4Q15 results in the coming weeks and will also provide initial investment guidance for 2016. There are likely to be negative surprises on the investment front as oil remains depressed. At least for the first half of 2016, I don’t see aggressive spending. If oil recovers during this period, capital spending can accelerate in the second half of 2016. In line with this view, there can be potential reduction in onshore rigs in the coming weeks, and this is likely to negatively impact the stock.
From an industry perspective, oil prices surged higher on last trade, but the upside was driven by buying at oversold levels. The oil glut, Iran supply factor and decline in consumption growth (weak economic activity) still remain dominating factors. Therefore, if oil retreats again, Patterson-UTI is likely to decline. In my view, once oil supply commences from Iran and once there is more clarity on global growth (especially China), oil will stabilize and gradually trend higher.
Considering these three critical factors, investors should remain on the sidelines even when the stock has corrected significantly.
Among the positive, the company’s balance sheet is healthy with $865 million debt, but no debt maturity before September 2017. Further, a majority of the debt is scheduled for maturity on or after 2020. With EBITDA of $484 million for the first nine months of 2015, debt servicing is not a concern.
2016 EBITDA can potentially be lower than 2015. However, debt servicing is likely to remain smooth. Further, $76.5 million in cash and $500 million in undrawn credit facility provide additional liquidity buffer. Overall, the balance sheet is not a concern for the next 12 months even on discounting further compression in EBITDA.
Leaving the financial factors aside, Patterson-UTI also has a high quality drilling rig fleet that makes the company attractive from a long-term perspective. With 161 APEX rigs and EBITDA entirely driven by the APEX rigs, Patterson-UTI rigs will find demand once markets start recovering. Factors such as walking rigs for pad drilling and latest technology availability for pressure pumping makes Patterson-UTI attractive among onshore rig service providers.
In conclusion, EBITDA margin compression can be expected in 4Q15 as well as further rig contract cancellations in the coming months. These factors can trigger further correction in Patterson-UTI, and it might therefore be best to stay on the sidelines for the foreseeable future. Patterson-UTI will be worth considering once volatility in the energy market declines.
Disclosure: No positions in the stock.
