Helmerich & Payne: Remain Cautious Even After Recent Upside

Dividend cut can translate into renewed stock downside

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Sep 25, 2017
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Helmerich & Payne (HP, Financial) has been in my investment radar for a long time, and I have been bullish on the stock from a balance sheet fundamentals perspective. With volatility in the broad energy industry, the trend for Helmerich & Payne has also been mixed.

Year to date the stock has declined by 34%. The stock bottomed out at $42.3 on Aug. 31. The stock is subsequently higher by 20.6% to current levels of $51.

I advise caution related to the stock, and investors can avoid fresh exposure at current levels.

The broad conclusion is to avoid buying Helmerich & Payne at current levels, but the stock is certainly worth tracking for exposure on renewed correction.

Can dividends sustain?

Helmerich & Payne reported decent numbers for the third quarter. The stock declined on concerns related to the sustainability of dividends. Citigroup analysts cut the company’s rating to “Sell” with the key concern being dividend cut in the foreseeable future.

The following are the key concerns that make me believe Helmerich & Payne can potentially trend lower on possible dividend cuts.

  • For Helmerich & Payne, the number of active rigs bottomed out in third-quarter 2016 at 87 rigs. Since then, the number of active rigs has been trending higher with average number of active rigs as of Sept. 7 being 194. The number of rigs on term contracts has increased gradually, and these rigs provide clear cash flow visibility. Amid this positive, the concern is EBITDA margin compression. Just to put things into perspective, Helmerich & Payne reported operating cash flow of $615 million for nine months of 2016 that has declined to $236 million for nine months of 2017. With capital expenditure of $300 million for the same period, Helmerich & Payne has reported negative free cash flow for nine months of 2017.
  • As pointed out above, Helmerich & Payne reported operating cash flow of $236 million for nine months of 2017 and for the same period, the company’s dividend payout was $229 million. Therefore, the company’s operating cash flow is entirely utilized in dividend payout, and the company’s cash buffer has declined to $610 million as of nine months of 2017 as compared to $950 million for the period ended fiscal 2016. If this trend sustains, cash burn would imply leveraging for dividends or investment. Helmerich & Payne would cut dividends instead of leveraging in uncertain times.
  • I am bullish on oil and black gold has consolidated in the range of $45 to $50 per barrel. I don’t see demand factors translating into strong upside for oil in the next 12 to 24 months. While oil can be in the range of $55 to $60 per barrel during this period, any renewed economic concerns can take oil lower. Land-drilling companies are unlikely to see renewed EBITDA margin expansion in the next 12 to 24 months. While rig utilization is likely to increase, compressed EBITDA margin will translate into weak cash flows.

Long-term view

Helmerich & Payne stock is likely to remain volatile in the coming quarters and potential cut in dividends can take the stock lower. Any deep correction from current levels will be an opportunity to consider exposure to the stock.

It is important to note that Helmerich & Payne is the leader in the land rigs segment in the U.S., and the company has the best fundamentals among peers. Further, with leading position in the land “A.C. Drive” rigs, Helmerich & Payne is well positioned for higher rig utilization in the long term.

I did discuss the company’s potential dividend cut, but I must also mention that for Helmerich & Payne, the fiscal 2017 and fiscal 2018 term contracts will ensure that the balance sheet remains healthy. While any potential cut might be painful for the near term, it will support long-term fundamentals.

Conclusion

Helmerich & Payne is a quality name in the land rig segment in the U.S. The company has one of the best dividends in the land rig industry and even if dividends are cut in the near term, investors should use the correction to accumulate the stock.

In the next three to four years, Helmerich & Payne is likely to be a value creator and I am bullish on oil for the long term.

Disclosure: No positions in the stock.