Significant Target Increase With “strong” price fundamentals, “something’s gotta give on valuations” for oilfield services providers in the near term, according to Stifel analyst Cole Pereira.
“OFS return metrics are near or above 10-year highs, FCF generation is at an all-time high and leverage is effectively evaporating from the sector,” he said. “However, despite these points the equities trade at a meaningful discount to prior activity growth years, which supports our bullish view on the space. We expect more modest forward activity growth but stronger pricing fundamentals, and favour businesses with a higher degree of pricing upside - namely drilling and pressure pumping. We view U.S. services as relatively lower-risk, however the Canadian outlook remains attractive and view any concerns on WCSB activity from the natural gas pullback as minimal given the catalysts.”
“The OFS sector’s fortunes have continued to improve as increasing demand for oilfield services and a dwindling supply of excess field-ready equipment have shifted supply-demand and pricing fundamentals in their favour. Moreover, the 3-year average ROCE for many names under coverage is well above the 2017-2019 peak and is near or above the 2011-2014 peak despite activity being meaningfully lower. Additionally, FCF generation is higher than it has ever been with more than half our coverage set to repay their EVs in approximately five years based off 2024 estimated FCF. This is also driving meaningful debt reduction with our sector experiencing an aggregate decline in net debt of 78 per cent to $1.4-billion from $6.2-billion over the next two years, with half of our coverage universe debt free by the end of 2024. We believe these points support higher valuations and yet the sector trades at EV/EBITDAS multiples of 3.8 times in 2023 and 3.5 times in 2024E vs. prior activity growth periods where the space traded at 6-7 times FTM [forward 12-month] EV/EBITDAS.”
In a research report previewing fourth-quarter earnings season in the sector, Mr. Pereira made a pair of rating changes.
He upgraded Enerflex Ltd. (EFX-T) to “buy” from “hold” with a $14.50 target, up from $9 and above the $12.58 average on the Street.
“We had downgraded EFX to Hold following its acquisition of Exterran corporation due to our view that the required working capital and capital expenditure investments would erode FCF generation in the near-term,” said Mr. Pereira. “However, the deal closed in early 4Q22 and with these investments largely taking place in 4Q22E and 1Q23E, we forecast the company to transition to positive FCF in 2Q23E. We forecast the company to generate meaningful FCF of $216-million in 2023E (18-per-cent yield) and $360 mm in 2024 (30-per-cent yield), which should see net debt/EBITDAS decline to 1.6 times by the end of next year. Moreover, we believe the stock has potential for further positive estimate revisions driven by a continued recovery in its core U.S. Engineered Systems business along with the progressing integration of the Exterran integration. The stock lagged its peers materially last year, returning 9 per cent from the date the Exterran deal was announced to the end of the year vs. the peer average of 57 per cent, but is up 13 per cent year-to-date vs. the peer average of 7 per cent.”