2Q23 - Strong balance sheet and FCF enable capital allocation juggling act
Our view: Pason reported in-line 2Q23 results. We continue to see value in Pason shares as the company demonstrates strong margins, free cash flow, and financial returns. In our view, Pason is also in a solid position to execute on its three capital allocation priorities including investing in its core drilling business, making incremental investments, and returning cash to shareholders. We maintain our Outperform rating and $17 price target.
Key points:
In-line results. Pason reported revenue and adj. EBITDA of $85MM and $38MM, respectively. Results were in line with our estimates of $83/38MM (Street $84/37MM). EBITDA margin of 44.7% was 40bps below our estimate and increased 260bp y/y. North America revenue per industry day of $910 was 3% above our estimate, and increased 14% y/ y. The improvement reflects higher product adoption and pricing. Pason generated ~$18MM of pre-dividend FCF (CFO-capex).
International revenue to outgrow North America in FY23. In 2023, we forecast Pason's NAM revenue to grow 5%, while International grows 19%. NAM represents about 80% of its revenue, with International slightly under 20%. In 2Q23, NAM revenue grew 13% y/y, versus a flat y/y North American land rig count. International revenue grew 22% y/y.
Funding longer-term growth potential through IWS investment. Pason outlined its three capital allocation priorities, including 1) strengthening its core drilling business, 2) Investing in growth beyond the core, and 3) returning capital to shareholders. Its non-controlling investment in Intelligent Wellhead Systems is an example of priority #2. Pason recently increased its investment via a $25MM preferred share agreement. Of which Pason has approved $20MM and we model the company investing the final tranche in 4Q23.
Estimate changes. We decrease our 2023 EBITDA estimate by 4% to $172MM, as noted in Exhibit 1. The changes are driven by modestly lower NAM revenues and margins. We expect Pason to generate $97MM pre- dividend FCF in 2023, mapping to a 9% yield and 27% margin of revenue.
Favourable relative valuation. Pason currently trades at 2023E/24E EV/ EBITDA multiples of 5.3x and 4.9x. Pason historically has traded at a 3.5x premium (~0.9-1.1x current) to land drilling peers. We expect the premium to be largely restored through the cycle.
Maintaining Outperform rating and $17 price target. Our $17 price target is based o e of our revised 2024 EBITDA estimate. We assign a premium multiple relative to our Canadian OFS coverage group based on stock-specific factors within our valuation framework.