PTEN’s Value Proposition
Patterson-UTI Energy’s (PTEN) confidence in the drilling activity improvement has been quite apparent over the past couple of quarters. As the energy price strengthens, more Tier 1 drilling rigs and frac spread will be added in 2022. The topline will improve from higher volume and increasing leading-edge day rates for the ESG-compliant equipment. Beyond 2022, the company expects to benefit from its current lithium battery management systems investment. As the financial performance improved, the company increased its dividend in early 2022.
Labor market inflation and higher reactivation expenses can dent the operating margin expansion despite the bullish environment. Due to higher working capital requirements, free cash flow turned negative in 2021. However, the company’s robust liquidity and deleveraging should keep the risk factors away in the short to medium term. I think the bullish factors will outweigh the negative factors, so investors should buy the stock.
Rig Upgrade And Premium Pricing
PTEN’s management sees the activity rise as a multi-year upcycle. By the beginning of 2022, the two principal themes driving Patterson-UTI Energy are premium pricing following the rig upgrade initiatives and increased capex on new technologies. Following energy operators’ pursuit of cleaner energy production, the leading-edge day rates for the Tier 1 drilling rigs are improving. A lack of premium equipment supplies in the pressure pumping business also led to a significant pricing improvement in both dual fuel and conventional spreads. The company plans to convert all its conventional spreads to ESG-compliant dual-fuel-capable pumps in 2022. I expect additional revenues from technological enhancement and ancillary services in contract drilling.
Many oilfield services companies have been upgrading their rig fleets, which will require dual-fuel electric pressure pumping fleets. So, theoretically, competition should intensify in the medium term. However, there are technological and cost barriers. For example, PTEN estimates that among the 300 rigs in the US that are apt for conversion into Tier I super-spec rigs, half are outdated, and the costs associated will be prohibitive. These will require higher day rates to remain operational in the current market. Currently, PTEN has 34 rigs that can be upgraded to Tier 1 super-spec capabilities for ~ $ 2 million each. In aggregate, it has 70 rigs equipped to operate with alternative power sources, including dual fuel and natural gas-powered engines.
Other Long Term Drivers
In 2022, PTEN will continue to invest in the EcoCell lithium battery hybrid energy management system. The cells will regulate stored energy to provide power to the rig when needed. Thus, it is expected to reduce fuel consumption by ~ 20%. This jibes well with the company’s ESG initiatives. I think the product will see strong demand from customers looking for sustainability solutions and attract a higher day rate, thus improving the company’s operating margin.
The Industry Indicators
The US rig count has continued to move up at a steady rate starting Q4 2021, after a brief pause in Q3. The energy price, too, has gathered pace in 2022. While the crude oil price remained unchanged and the natural gas price declined in the final leg of 2021, they bounced back in 2022 so far (up 23% and 26%, respectively). The primary reasons for the price hikes are the easing of the COVID restrictions and OPEC production falling short of expectations.
With pricing moving up, management expects adjusted EBITDA to exceed $ 450 million in FY2022, a 163% rise compared to FY2021. Although the energy prices go up, the supply of premium equipment in contract drilling and oilfield services sectors has been tight. So, it expects strong EBITDA growth in 2022 compared to 2021. Also, it plans to increase maintenance and reactivation capex, although it can limit it to investments that have a quick payback and a high return.
Contract Drilling Segment: Analyzing Outlook And Performance
In Q1 2022, the company expects the rig count to increase to 116 rigs from 106 in Q4 2021. In January, it already had 113 drilling rigs in place. The average revenue per operating day can increase by 4%, while the average direct cost can fall marginally, leading to an ~ 18% rise in the average margin in Q1. In Q4 2021, although PTEN’s average revenue per operating day increased (1% up) quarter-over-quarter, it was more than offset by higher direct costs, leading to a 13% fall in the average margin. An increase in labor and rig reactivation costs prompted a steep cost hike. Based on the contracts for drilling rigs currently in place in the US, the company expects 51 rigs to operate under term contracts in Q1.
Pressure Pumping Segment: Performance And Outlook
In Q1, PTEN expects Pressure Pumping segment revenues to increase by 9% compared to Q4 as it implements a price hike and additional revenue from rig reactivation in Q4. Despite adverse weather, the adjusted gross profit can increase considerably (29% up) in Q1. In late Q4, the company added a dual fuel frac spread, while in Q1 2022, it may take the tally to 12. The US frac spread count increased by ~ 18% in Q1 so far, according to Primary Vision.
Because dual-fuel capable pumps reduce fuel costs and emissions, they have been fetching higher leading-edge rates in recent times. In 2022, the company plans to convert all 12 of its pumping fleet to such capability, improving its gross margin further. The Pressure Pumping segment revenues went up by 20% in Q4 compared to Q3. However, the average margin per fracturing job was contracted by 30 basis points in this period.
In 2022, PTEN has doubled its annual dividend to $ 0.16 per share. Its forward dividend yield is 1.15%. In comparison, Helmerich & Payne’s (HP) dividend yield (2.9%) is higher.
Capex And Debt
In FY2021, PTEN’s cash flow from operations (or CFO) declined by 66% compared to FY2020. Despite 21% higher revenues in this period, adverse changes in working capital caused the CFO to fall. Capex increased by 14% in the past year. As a result, free cash flow (or FCF) turned negative in FY2021. In FY2022, its capex can more than double. While maintenance and rig reactivation following higher activity levels will account for, a considerable capex will be spent on the EcoCell units and additional dual fuel and natural gas engines. Higher capex can put further pressure on the FY2022 FCF.
The company had $ 718 million in liquidity (cash & equivalents plus revolving credit facility available) as of December 31, 2021. During Q4, it repaid the $ 50 million of its debt. It also expects to reach net debt to trailing EBITDA of 1.5x by the end of 2022. In December, it sold the well service rig business and wireline business it had acquired as part of the Pioneer Energy Services acquisition. It may use the sale proceeds to lower debt further. Thus, the company’s balance sheet has low near-term financial risks.
What Does The Relative Valuation Imply?
Patterson-UTI’s current EV-to-Revenue multiple is 2.7x. The stock’s past five-year average EV / Revenue multiple was 1.9x. So, it is currently trading at a premium to its past average.
PTEN’s EV / Revenue multiple is higher than its peers’ (NBR, HP, and LBRT) average of 1.9x. Because PTEN’s forward EV-to-Revenue multiple contraction is steeper than peers, I would expect its EV / Revenue multiple to be higher. So, the stock is reasonably valued at the current level.
Analyst Rating And Target Price
According to data provided by Seeking Alpha, 11 sell-side analysts rated PTEN a “buy” in February (including “Strong Buy”), while three of the analysts rated it a “hold.” Two analysts rated it a “sell.” The consensus target price is $ 12.67, suggesting a 9% downside at the current price.
According to Seeking Alpha’s Quant Rating, PTEN receives a “Hold” rating. While the ratings are high on growth, momentum, and revision, they are low on profitability and valuation criteria.
What’s The Take On PTEN?
After adding 26 rigs in Q4, PTEN plans to add ten more rigs in Q1 2022. The leading-edge day rates for the Tier 1 drilling rigs are improving. It also plans to convert the majority of its conventional spreads to ESG-compliant dual-fuel-capable pumps in 2022. Day rates are improving, and the technological enhancement and ancillary services in contract drilling will widen its revenue base in 2022. A robust topline in recent times prompted the stock to outperform the VanEck Vectors Oil Services ETF (OIH) in the past year.
PTEN faces margin headwinds from cost escalation due to supply chain issues. Plus, an increased activity level led to a rise in rig reactivation cost and a higher working capital requirement, leading to significant pressure on free cash flow. Investment in new technologies can increase capex in 2022. Nonetheless, the balance sheet is robust with sufficient liquidity while lowering the debt level. Investors can buy the stock with an expectation of steady returns in the medium term.