RBC Notes July 7, 2022
Oil & Gas Services 2Q22 preview Never a dull moment
Our view: Fundamentals within the energy sector appear strong as oil markets remain in a tightening cycle, North America and global rig counts increase, and equipment & labour capacity tightens across the oilfield services sector. The aforementioned fundamental factors lead us to increase our 2022/23 EBITDA estimates by 3/10%, while the recent pullback in stock prices leaves the sector trading well below its mid-cycle average multiples which we believe presents a buying opportunity on balance. Our preferred stocks are SLB, HP, PD, PSI, and SES.
Activity levels and equipment utilization remain fundamentally strong. In 2Q22, the US rig count increased 13% sequentially, while the drilled-uncompleted well count decreased by 3% through May. Canadian rig counts increased 27% y/y, and exited June at 174, setting up for strong third quarter levels. We have increased our North American land rig counts for 2022/23 to 879/980 from 849/945. Leading rates for top quality rigs exceeds $30k/day, versus $25k/day entering 2Q22. We estimate our land drilling services coverage group has approximately 40 rig contracts expiring beyond 2022 out of about 480 currently active rigs, allowing the majority of rigs to be re-priced at prevailing rates into 2023.
Margin expansion remains key ingredient to stock performance. We expect second quarter results to include 359bps annual margin expansion due to 1) Higher US drilling and completions activity, as evidenced by the 13% sequential improvement in industry rig counts, 2) Higher service pricing, as contract books for rigs and frac crews re-price toward prevailing spot rates, and 3) Operating leverage on generally tighter capacity utilization. We expect increased E&P budgets in the second half of the year could present a catalyst for the sector.
Modestly above the Street for 2Q22; Increasing 2023 estimates. Our 2Q22 EBITDA estimates are 2% above the Street in aggregate. We are 3% above the Street in Land Drilling and 1% above the Street for Frac Services, as shown in Exhibit 9. In large caps, we are in-line with Street consensus for SLB & HAL, and modestly below on BKR. We have increased our 2022/23 EBITDA estimates by 3/9% and Exhibit 10 contains a full breakdown of our revenue, EBITDA, and EPS estimates. In 2023, our EBITDA estimates include 96% y/y growth with 359bps of margin expansion, and we are above the Street in land driling (+3%) and equipment and diversifed services (+5%) and below Street for large cap diversified (-1%) and frac services (-2%). We have also revised price targets for select names; please see Exhibit 11 for details.
Recent downward pressure on stocks has de-risked valuation multiples. We think the recent downward move in stocks (OIH down 31% in the last month, in-line with XOP) has de-risked EV/ EBITDA valuation multiples for the sector. As noted in Exhibit 7, multiples are below mid-cycle averages across the board, with many stocks at trough levels. While potential risk of recession looms, our commodity strategists believe the oil market remains in a structural multi-year tightening cycle and forecast $107.45/114.00/bbl WTI crude prices in 2022/23. Further, tight commodity supply/demand balances should support drilling & completion activity while resistance to add equipment capacity should provide support to margins and future EBITDA revisions.
SLB and SES remain on Global Energy Best Ideas List; Land drilling an attractive sector. Schlumberger (NYSE: SLB) and Secure Energy Services (TSX: SES) remain on our Global Energy Best Ideas list. We also see upside in land drilling stocks as domestic and International rig counts improve and rigs re-price at higher dayrates through 2022/23. Our preferred names in land drilling are Helmerich & Payne (NYSE: HP), Precision Drilling (TSX: PD, NYSE: PDS), and Pason Systems (TSX: PSI).