NEX - NexTier Oilfield Solutions: Consider Taking Some Profits After The Rally

2023-08-17 15:34:28 ET

Summary

• NexTier is up quite a bit over the last couple of months.
• Fracking companies were priced for the worst, which hasn't materialized despite the observable slowdown in U.S. onshore oilfield activity.
• The valuation gap has now closed a bit and NexTier has also in the meantime announced a merger with Patterson-UTI.
• Until the merger starts delivering the promised synergies, I don't see any imminent catalysts other than the broader movements in oil and gas prices.

Investment thesis

The regional banking worries back in March, on the back of already crashing natural gas ( NG1:COM ) prices, opened up a decent value opportunity among some premium onshore oilfield services names, including NexTier Oilfield Solutions ( NEX ). As the stock went up 40% since my prior article in May, it's probably a good time to update our thesis:

The fundamental part of my argument seems to be largely holding out so far. Onshore oilfield activity indeed moderated but it didn't fall through the floor. NexTier, as well as other onshore services companies, are now calling the bottom sometime this Q3.

On the other hand, the 40% run-up has closed up the valuation gap to some extent. Forward P/E was at 2.6x when I wrote the May article . It has since risen to 4.2x:

It is still a very good deal but a bit less so. More importantly, NexTier also entered into a merger agreement with Patterson-UTI ( PTEN ) back in June. I wrote too about my thoughts on the merger and concluded that the deal seemed fair to both sides.

Nonetheless, since the announcement, one NEX share is basically worth 0.752 PTEN shares based on the merger terms so the NEX price now rather reflects the prospects of the future company. I do think the PTEN-NEX combination will be a powerhouse for the reasons I covered before, but the market will probably want to see some evidence the merger is working out.

The two managements have promised, for example, $200 million in annual synergies, which by my earlier estimate is about 10% add-on to the combined pro forma EBITDA. It will take some time for the integration to achieve its targets, so in the meantime the major catalysts may be just the broader moves in oil ( CL1:COM ) and natural gas prices.

I am long NexTier's competitors Liberty Energy ( LBRT ) and ProPetro ( PUMP ), which also provide fracking services and too saw impressive run-ups:

However, consistent with my current sentiment toward NexTier, I have scaled down my LBRT and PUMP positions in the anticipation of a possible correction.

NexTier sees onshore activity bottoming soon

NEX had its Q2 earnings call recently. Impressively, the company posted a modest 1% sequential increase in revenue, despite the falling activity drivers:

Frac fleets are also down from last year and at multi-week lows although they bounced back a bit:

Similarly to its competitors, NexTier thinks the activity bottom is near:

In the near term, we think the U.S. land rig count will likely bottom this summer with industry frac activity potentially down further from current levels with a trough likely coming later this year. Importantly, we anticipate trough utilization will be significantly higher than the industry has traditionally experienced; a strong indication that the longer term uptrend for the industry is still intact.

Source: Q2 2023 earnings call

NexTier expects a strong start to 2024:

Despite near term economic uncertainty, all signs point to higher global oil demand over the coming years and accordingly, we believe U.S. land oil activity will need to move higher than current levels as production will need to increase. We see the availability of frac fleets once again as the bottleneck to U.S. oil and natural gas production growth by as soon as 2024.

Source: Q2 2023 earnings call

Fracking companies are also more conscious of managing supply this time around and prefer to idle fleets than to erode pricing:

During Q2, we idled two frac fleets and redistributed the horsepower to our remaining fleets, with opportunities to optimize horsepower levels across all fleets, given the high intensity required by the modern frac job. We could idle up to three additional fleets in Q3.

Source: Q2 2023 earnings call

The quality of equipment continues to matter as well as who your customers are, and NEX believes it has an advantage in both areas. Its now partner PTEN is also a premium services provider in the drilling space though it has a bit too much of exposure to private operators compared to some other drillers:

However, in the shorter term, I probably see more downside risk associated with integrating the two legacy companies.

Michael Burry bought NexTier too

Investment legend Michael Burry's Scion Asset Management also disclosed a Q2 position in NexTier in the recent 13-F filing:

Interestingly, Burry's fund also had a position in Precision Drilling ( PDS ), another onshore oilfield services player, which runs premium land rigs. PDS had similar performance as NEX, PUMP and LBRT over the last months:

Unfortunately, we won't know if Michael Burry already sold until the Q3 filing, which won't be available for quite a while.

However, what we do know is that NexTier's CEO sold $5 million worth of shares recently:

The CEO still has a lot of shares left, but perhaps this proves the point that after a strong run-up it's prudent to take some profits.

Bottom line

Wall Street gives about 20% upside to NEX from the current levels:

However, when I wrote my prior article, the Wall Street target upside was 70%:

I remain long both LBRT and PUMP but have scaled down after the recent run-ups. I would approach NEX the same way, but I am already overweight oilfield services. Everyone's individual circumstances will be different of course.

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