National Bank Canada’s oilfield service sector continues to benefit from “relatively stable” activity and utilization, while pricing and margins are “proving well insulated from the forces of competition or inflation” heading into first-quarter earnings season, according to National Bank Financial analyst Dan Payne.
“As shown through our upstream outlook, commodity prices remain range-bound (with a positive bias) and activity remains structurally unchanged, as a function of the preponderance of cash flow that is fixed to return of capital initiatives (as opposed to reinvestment); any projection towards an inflection to growth and expansion within the sector remain medium-to-long term in orientation, at best,” he said in a research report titled Top Quality Rocket ... Waiting for Liftoff.
“As such, the OFS group should continue to prove value through a) decoupling of returns from activity, in support of b) resilience and quality of earnings, which in the absence of reinvestment (either organically or acquisition), should reflect ample free cash and return of capital for those operators best positioned (entrenchment, technology and ancillaries proving impactful). With that, we continue to expect funds flow to continue to bias multiple expansion to compound shareholder value through this phase of the cycle, before greater upside is more visible with a further inflection over the medium term.”
Mr. Payne updated his forecast for companies in his coverage universe to reflect both his upstream macro and commodity price revisions as well as activity forecasts.
“Our revised forecasts (commodity and activity) sees us largely maintain our estimates (negative 3-per-cent change on average), relatively tightly aligned with consensus (generally in line), while implying little rate of change (5- 10 per cent per annum), again, suggestive of the resilience and quality of earnings within the group, which should offer ample excess cash flow and prospective return of capital in support of shareholder value for a group that remains discounted relative to historical (27 per cent),” he said.
“In general, we remain Sector Perform for the group (as relative biases are hard to distinguish; ‘dealer’s choice’), but do hold a pecking order of EFX, PSI, PD, TCW and CEU (while acknowledging the almost indistinguishable value-adjusted returns therein).”
Mr. Payne made one target adjustment, raising CES Energy Solutions Corp. to $6.50 from $4.75 with a “sector perform” recommendation. The average on the Street is $6.29.
“Increasingly noted as the highest-quality in the group, particularly on the back of the industry-transformative SLB/CHX transaction (8 times EV/EBITDA), we believe the positive bias to CEU’s business will only increase; where its market share and margin potential should grow as industry backfills for the absence of CHX,” he said. “Again, its assets are ideally suited to take leadership in the group, with a dynamic approach and highly customer-centric stance that should increasingly benefit from thematic tailwinds of higher intensity and increased consumption of chemicals (drilling longer/faster + optimizing production), each to prove a de-coupling of revenue from otherwise anemic industry activity levels and positively reflected through first quarter results. With that, look for revenue of $560-million (up 1 per cent quarter-over-quarter) and associated EBITDA of $82.4-million (down 3 per cent quarter-over-quarter) to suggest a margin of 15 per cent (from 15 per cent), which sits in line relative to consensus and should positively validate the strength of its fundamental foundation (i.e., market share and revenue per rig per day). Ultimately, we continue to expect validation of expanding returns, set against its capital light model ($70-million), to continue to support solid free cash in support of de-leveraging (long-term option value) and its cash dividend (3-per-cent yield) plus buyback (upon renewal of NCIB in Q3), each likely to support an expanded multiple backdrop for the stock (trading at 3.2 times vs. peers 7.1 times). With that, and frankly, our increasing appreciation for the story, we are increasing our target.”
He maintained his targets for these stocks:
- Enerflex Ltd. ( “outperform”) at $10. Average: $11.10.
- Precision Drilling Corp. ( “sector perform”) at $135. Average: $127.49.
- Pason Systems Inc. ( “sector perform”) at $20. Average: $18.57.
- Trican Well Service Ltd. (“sector perform”) at $6.75.
“Overall, we continue to believe the market remains relatively well balanced, but the risk-adjusted value proposition remains stout as the quality and stability of earnings (shown through high cyclic ROCE) is better appreciated and funds flow continue to emerge in support of multiple expansion off a low relative multiple. Based on commentary within and throughout, we believe that operators with high-quality entrenchment of operations within the best insulated and diversified businesses should prove preferential results, and which has us biasing our names (per a scorecard approach for earnings momentum and relativity of value-adjusted returns) as EFX, PSI, PD, TCW and CEU (while acknowledging the relatively indistinguishable value-adjusted returns therein).”