CANADA BEATS USA GOLD IN OIL PATCH DIVIDENDS

INTRO

Oil Field Services (OFS) was a top “Trump Trade” for the 3.5 weeks between the first presidential debate and Joe Biden ending his re-election bid. The Market considered Trump a “gimme” to win the November election.

But is OFS still a Trump Trade—even if he wins the now much-tighter election campaign?

I say YES—but the trade is in Canada, not the US.  Valuations are just as cheap in Canada as in the US…AND…the Canadians are paying dividends.  The US sector—other than The Big 3 (SLB, HAL, WFRD) is mostly not.

Here is Part 1—why the OFS sector in the US is NOT The Trump Trade—even if he wins.

There has been a rotation away from energy names in the United States.  The energy weighting of the S&P is down to 3.5% of S&P 500 vs. recent peak of 4.2% at the start of 1Q earning season in April.

Taking a step out, while the broader market has rallied since the fall, the oilfield services (OFS) index has done not much at all.

Click to Enlarge

Source: Stockcharts.com

Small caps that have taken the brunt of that rotation.

That is not to say that large cap OFS is expensive – companies like Halliburton (HAL – NYSE) and Baker Hughes (BKR – NYSE) trade at a discount to the market.  But they are much more expensive than their smaller-cap peers.

Small-cap US OFS is priced similarly to their Canadian counterparts – in some cases even cheaper!

But there may be a reason for that.  I don’t see the same discipline to shareholder returns from the US names as with Canadian counterparts.   In Canada, the message is clearly one of returns to shareholders.

Most US names are not paying dividends,  Growth capex spend seems to be favored over shareholder returns.  There are some buybacks, but not to the same extent as in Canada.

At the same time, the drilling landscape in the US looks less positive than Canada.  The pricing power of the Canadian sector is more positive.

Finally, the withdrawal of Joe Biden and replacement of Kamala Harris is a new wrinkle.  Harris has been much more vocal against fracking.

Lots of worries!  But could it all be priced in?

The US OFS sector is a contrarian’s dream.  Which is maybe the play to watch.  The slightest positive news for the sector could quickly change the direction of these stocks.

DIVIDENDS ARE ELUSIVE

The overall US market today is bifurcated.  Investors pay one price for large caps and another, much lower one, for small caps.

The US OFS sector is no different!  Large cap stocks trade at much higher multiples and offer only small dividends to investors.

Baker Hughes has an 84c per share dividend, payable quarterly.  The stock is at $36, which makes this a 2.3% dividend yield.  Baker Hughes trades at 16x earnings and 8x EBITDA.

Halliburton pays a 68c dividend.  They have a 1.8% dividend yield.  They trade at 10.5x earnings and 7x EBITDA.

These valuations aren’t expensive compared to tech or the Mag-7, but they also aren’t screaming deep-value.

There are better valuations if you step down to smaller names.

Smaller players like Liberty Energy (LBRT – NYSE) are returning more cash to shareholders.  Liberty is a best-in-class pressure pumper in the US.

Liberty is buying back stock at a $30M per quarter pace and is expected to generate a 12% FCF yield this year.

But dividends remain elusive. Liberty only has a 1.1% dividend yield.  ProFrac (ACDC – NYSE), another pressure pumper with lots of FCF, also gives no dividend yield.

Where dividends are more easily found is in the gas compression space.   Archrock (AROC – NYSE) is an outsourced compression provider.  They recently revised their 2024 EBITDA up by $10M after posting good Q1 results.

Click to Enlarge

Source: Archrock Investor Presentation

Archrock trades at 17x P/E and 8.5x EBITDA.  They offer a somewhat more beefy dividend of 3%.

USA Compression (USAC – NYSE) offers a far higher dividend yield of 8.7%.  But with it comes more leverage.   USAC comes with $3.5B of debt – about a 6x debt/EBITDA ratio.

THE US MARKET ISN’T STRONG

We haven’t experienced a downturn in oilfield services since COVID.  But make no mistake, the US OFS landscape has seen better days.

The rig count has been falling.  Day rates have been falling.  While that weakness may be showing signs of a bottom, there is no sign of a pickup just yet.

Bank of America recently commented that the “US land oil production growth is slowing materially”.

Similarly, Morgan Stanley lowered US activity estimates 5-15% for 2024. Morgan Stanley saw more downside to the rig activity (drilling) than to frac activity.

BofA, Morgan Stanley and other analysts have been surprised by the weakness in drilling activity this year.

They lay blame on “bloated OPEC plus spare capacity plus growing production in key non-OPEC/US countries”.

Many of the US focused OFS companies are echoing the sentiment.  Liberty expects that the completions market “will remain soft” in 2024.  ProFrac called out weakness in natural gas activity on their last call.

LOOK TO THE SEA?

With onshore drilling muddled in weakness, Bank of America makes the case that more drilling dollars will be headed out to sea.

In a recent piece, BofA said that they expect onshore drilling and completion spend to be relatively flat YoY, and to increase only a modest 5% in 2025.  But they expect the offshore market to do much better.  Offshore spending is expected to climb 10% this year and 8% in 2025.

Click to Enlarge

Source: BofA Research

While offshore drilling is typically more expensive than onshore, costs are low enough that today 90%+ of undeveloped reserves are economic at $70/bbl+.

Click to Enlarge

Source: Valaris Investor Presentation

Meanwhile, offshore rig utilization is back to levels not seen in 10+ years.

Click to Enlarge

Source: Valaris Investor Presentation

It seems bullish, but that has only modestly shown up in the stocks.

One of the biggest offshore drillers, Transocean (RIG – NYSE), is barely off its the 52-week lows.

Click to Enlarge

Source: Stockcharts.com

Transocean provides offshore drilling services.

Transocean agrees with Bank of America.  They project robust demand for floater rigs over the next few years.  They own and operate 37 harsh-environment and ultra-deep water drilling rigs.

Click to Enlarge

Source: Transocean Investor Presentation

Transocean trades at 7x EBITDA.  Because of their debt, their FCF yield on the shares is significant.

A second offshore is Valaris (VAL – NYSE).  Valaris has a rig fleet of ultra-deepwater drillships with the largest fleet in the industry.

Click to Enlarge

Source: Valaris Investor Presentation

Valaris is signing contracts today with day rates at $450K+.   A few years ago, day rates were less than half that!

Click to Enlarge

Source: Valaris Investor Presentation

Valaris is still working off lower rate contracts which will depress earnings this year.  Their legacy contracts for drillships average $250K versus $450K for more recent deals.  In 2025, estimates are for $9.63 EPS which puts the stock at just 7.7x P/E.

SO BEARISH ITS BULLISH?

While the set-up for offshore drillers looks decent, the onshore OFS sector in the US could be a rough go.  There is continued pricing pressure, downward pressure on the rig count and plenty of oil coming from abroad (including Canada).

Add one more worry – the specter of a Harris presidency.

But maybe that is exactly what makes this set-up so bullish?

The US OFS sector is far from expensive.  The large cap names trade at a significant discount to the S&P.  Small cap names trade at a significant discount to the large caps!

I already mentioned Liberty.  Another pressure pumper, ProFrac, is trading at $7.55, which is not just a 52-week low, it is an ALL-TIME LOW!

ProFrac is trading at 6x 2025 earnings and only 2.9x EV/EBITDA.

Yes, ProFrac is experiencing depressed frac-spread pricing.  Yes, that is expected to continue for the foreseeable future.   But maybe it’s all priced in?

Consider that at today’s pricing ProFrac is still generating significant FCF.  And because the price of the stock is so depressed, the FCF yield on the stock is over 20%!

I am always going to wait for the chart to give the go ahead.  With ProFrac and the rest of the OFS, we aren’t there yet.

But these are charts to keep an eye on.  The negative sentiment seems extreme.  It won’t take much in the way of positive news to move these stocks given the negative sentiment that dominates today.

Keith Schaefer