NEX - Nabors Industries: Don't Worry Too Much About The U.S. Rig Count

2023-05-30 10:18:49 ET

Summary

• Nabors Industries' stock price has underperformed YTD due to macro concerns and weak gas prices, but its fundamentals suggest a value opportunity.
• The company's advanced drilling technology and global presence provide moats even if U.S. shale activity slows down.
• The guided FCF yield to market cap is 46% and analyst targets suggest 70% average upside.
• I don't see the debt at risk, but the leverage may magnify the effect on the market cap if multiples compress further due to more negative macro events.

Nabors Industries ( NBR ), the owner of one of the world’s largest land-based drilling rig fleets, has had underwhelming stock price performance YTD, even relative to the oilfield services sector ( OIH ):

Nabors traded around $200 in February but is only $90 now.

The reasons for the sell-off are similar to the ones I addressed in my recent analysis of the pressure pumping stocks Liberty Energy ( LBRT ), ProPetro ( PUMP ) and NexTier Oilfield Solutions ( NEX ):

• Week natural gas ( NG1:COM ) prices forced the expectation that gas-focused basins like the Haynesville would be dropping rigs - and some of these rigs may relocate to oil-focused basins where they would compete for work and erode drillers' margins;
• Recession fears, exacerbated by the regional banking crisis, increased the pressure on anything oil or gas related.

In my view, Nabors' fundamentals aren't as endangered as the stock price suggests and this opens up a value opportunity:

• The bifurcation between high- and low-spec oilfield services providers is increasing and Nabors is a premium provider;
• The high decline rates of U.S. shale will necessitate a lot of drilling, even at low to moderate oil prices;
• Nabors is a legitimately global company that operates in 15 countries and derives significant revenue from Saudi Arabia - I find it extremely unlikely that both U.S. and international drilling capex will stall at the same time.

My long-term opinion of Nabors is a definite "buy", but I would caveat that the relatively high leverage means that small changes in the EV/EBITDA multiple could mean large changes in the market cap. To ensure some safety margin, I am inclined to wait a bit for the next bad macro day before I initiate a position.

Premium suppliers have a moat

The U.S. oil and gas rig counts have fallen in the last weeks:

However, Nabors has "one of the world’s youngest and most advanced fleets in the gas drilling and land drilling industries" including programmable rigs and higher horsepower. Nabors recently announced that its first fully automated rig - which was also the first one in the world - had successfully drilled its first well. Modern rigs with superior technology drive efficiencies for their E&P customers; when headline rig counts fall, the older or underperforming rigs are likely to get idled first.

From the Q1 earnings call :

[One] of the things I've got to bear in mind here is that the super-spec utilization percentage is still around 80% with all this. And there is a difference between those rigs and the other rigs. And that's giving support to this pricing structure right now. So that's why we're still constructive on the whole environment there. Obviously, when people move some rigs into the basin, it creates some downward pressure, just by way of background, we had -- I think we had rigs pricing in the low 40s for just earlier in the quarter. So that has come in to the high mid-30s, but it's still very constructive. And given the utilization percentage, we still remain pretty satisfied with where things are.

Shale operators can't afford to stop drilling

The decline rates for U.S. shale are an aspect that is catching a lot of attention lately, including recent comments from Warren Buffet and Charlie Munger. Shale, oil or gas, needs to do quite a bit just to maintain production; the chart from NoviLabs and oilprice.com makes the point clear:

Furthermore, the drilled but uncompleted (or "DUC") inventory is still at record lows:

The Permian DUC inventory is now comparable to its 2014 levels, when the Permian production was only 35% of what it is now; this is probably not a level that can support further growth.

Shale operators will likely continue to emphasize capital discipline, especially with $70 oil, and try to maintain production flat. However, with 40% decline rates, staying "flat" still requires a lot of drilling, especially with the low DUC count.

I am of the view that shale E&P players, especially the public ones, will accept capex increases, but no one would want go into an earnings call with numbers showing declining production. Persistently falling production would signal to the market that the company is on the path to self-liquidation. I think that may compress multiples even further. The imperative to "stay flat" is perhaps one reason why we see lately increased M&A focused on acreage, such as Chord Energy's ( CHRD ) recent purchase in the Williston Basin. The acreage buyers in these recent transactions are purchasing to drill; no one right now would use excess cash to buy an asset and keep it dormant.

Nabors is also an international play

Even if we assume the worst for U.S. land drilling activity, Nabors is far from a domestic driller:

In addition to a small offshore fleet of 29 units, of Nabors' 300 land rigs, only 167 are in the Lower 48: 16 are in Alaska and 117 are international, of which 49 alone are in Saudi Arabia. Saudi Aramco's capex plans to expand capacity to 13 million bbl/d day production by 2027 are not a secret - these are also long-cycle barrels and won't be as sensitive to current oil prices as U.S. shale. The international exposure can act as a "moat" to mitigate potential negative effects of the more volatile shale activity.

Valuation

At first glance Nabors doesn't look great on EBITD and EBIT valuation multiples, but management is guiding toward $400 million free cash flow for 2023:

We are currently reviewing our capital expenditure plan for 2023 to reflect the current market environment. We expect CapEx reductions in the Lower 48 and Colombia. We are targeting second quarter free cash flow approaching $50 million. For the full year, we still expect to deliver free cash flow in the $400 million range.

The current market cap is $862 million according to Seeking Alpha, which is an eye-catching 46% yield. The debt is high, but rated B+, which doesn't signal imminent distress. The FCF will also provide for meaningful deleveraging.

Risks

The main risk perhaps is that, because of the leverage, a small EBITDA multiple compression could be a more significant fall in market cap. I would prefer to have a bit more "safety margin", perhaps if another macro event results in a "red" day for oil stocks in general. With the debt ceiling situation and the possibility of even further Fed hikes, I think it's likely we'll see at least a few more days like that in the near future.

Takeaway

Wall Street analysts see an average upside of 70%:

Even on the lower end of these estimates, the upside is not trivial. I also think Nabors is a "buy", but I am trying to be a bit more strategic about when to pick up shares. I also already have significant OFS exposure through other investments, some of which are mentioned in the article.

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