For onshore drillers, there are clear signs of stabilization for the industry based on the rig count even when it’s too early to talk about any EBITDA margin expansion.
On my radar, I have two onshore drilling stocks and I recently discussed Helmerich & Payne (HP, Financial) with a view that the company’s fundamentals are strong, but potential dividend cut can take the stock lower. I maintain a bullish view for the long term on the stock, and any near-term correction will be a buying opportunity.
This article will address the other onshore driller on my investment radar – Patterson-UTI Energy (PTEN, Financial).
Patterson-UTI Energy has declined by 24.9% year to date, but the stock has recovered from 2017 lows of $15.3 and currently trades at $20.8. I see the positive momentum for the stock sustaining, and this article will address the key factors supporting my view.
Strong fundamentals
The balance sheet and cash flow factors are critical for discussion as industry recovery is likely to be gradual. For Patterson-UTI Energy, fundamentals are strong and even if industry growth remains slow for the next 12 to 24 months; the company is likely to emerge from the crisis with healthy credit metrics.
As of June 30, the company had long-term debt of $599 million, but that’s not a concern considering the following additional factors:
The company’s net debt to capitalization as of June 30 was 15.7% with no debt maturity until October 2020. With high financial flexibility and extended debt maturity, the company is well positioned.
For the first half of the year, the company reported adjusted EBITDA of $142.8 million and for the same period, the company’s cash interest expense was $16.6 million. Considering annualized numbers, the EBITDA interest coverage comes to 8.1. Therefore, debt servicing is likely to be smooth in the coming years. Even if the EBITDA shrinks further, I see no concerns related to debt servicing.
With these two key factors in consideration, the company’s balance sheet is strong, and I don’t see any credit stress.
Stable rig count in operation
As of July Patterson-UTI Energy had 162 rigs in operation. For August and September the number of rigs in operation has remained stable at 162 levels. This is a key positive and is indicative of stability in the industry.
I must point out here that Brent has moved higher in the recent past and if positive momentum for oil sustains, I expect Patterson-UTI Energy to report improved rig count in the coming months.
While rig count is an important indicator of stability in the industry, another factor that needs to be discussed here is the company’s EBITDA margin. For the second quarter Patterson-UTI Energy reported EBITDA margin of 13.7% as compared to EBITDA margin of 24.1% for second-quarter 2016.
EBITDA margin has compressed significantly in the last 12 months, but I don’t expect further compression in EBITDA margin in the coming quarters. As quarterly numbers indicate that, I expect the stock to move higher.
Positive on acquisition
On Sept. 5 Patterson-UTI Energy announced the acquisition of MS Energy for a consideration of 8.8 million shares of Patterson-UTI common stock and $75 million of cash.
There are several important points to note here:
- The acquisition is an indication that the management is relatively confident of sustained recovery in the industry and is using the financial flexibility to acquire assets at attractive valuations.
- MS Energy has an established position in directional drilling and for Patterson-UTI Energy, the acquisition serves as a tool to gain exposure to the North American unconventional drilling activity.
- MS Energy has patented technology called Clean Communications and this saves drilling time and expense for E&P companies. With industry on a recovery phase, cost is an important consideration for oil and gas companies, and the patented technology should help Patterson-UTI Energy to offer attractive service to the clients.
Conclusion
Patterson-UTI Energy has been lower year to date, but the company’s fundamentals remain strong. The EBITDA margin compression is the key factor that has kept the stock depressed, but EBITDA margin will stabilize at current levels before gradually improving.
Further, as rig count stabilizes and potentially increases in the coming quarters, Patterson-UTI Energy is likely to see positive momentum. It is important to note that even at $55 to $60 per barrel, there are several assets in the U.S. that deliver attractive IRR. This factor should keep onshore drillers relatively busy.
Disclosure: No positions in the stocks discussed.
