NINE - Nine Energy Service: Medium-Term Demand And Modernization May Offset Short-Term Headwinds

2023-04-17 21:46:24 ET

Summary

• Nine Energy's pricing can strengthen in Q1 because of equipment undersupply and low investment.
• It plans to convert four hydraulic wireline units to electric in 2023.
• The company's revenues and operating margin can remain muted in Q1 2023.
• At the start of FY2023, it restructured debt and extended the debt maturity.

NINE's Strengths And Challenges Ahead

In 2023, Nine Energy Service ( NINE ) will look to consolidate its wireline and completion tools market share and speedy conversion of wireline units to electric. The electrification initiative will not only bring in the advantages of additional savings, but an increased use of dissolvable plugs also reduces greenhouse gas emissions. On a better turn of events, its cash flow generation turned positive while it refinanced its debt structure and extended the liquidity base.

With negative shareholders' equity, the balance sheet restructuring can help alleviate investors' concerns. But the company will have to tackle the impending challenges in the short term. Given the precipitous fall in natural gas prices and upstream operators' shyness in capex commitment, its revenues and operating margin can shrink in Q1 2023. NINE stock appears to be mildly overvalued versus its peers. Investors would need to "hold" it, expecting improved returns in the medium-to-long term.

Analyzing Pricing And Strategy

We discussed Nine Energy's strategies and drivers in our previous article . Continuing with the story unfolding in Q3, equipment undersupply, insufficient capital for investment, and labor market constraints – all point to a price strengthening in Q4 2022 and 2023.

In this environment, Nine Energy looks to wrestle market share gains. To achieve this, it increased the percentage of stages completed within wireline and completion tools in 2022 while it grew the number of rigs and basins it operates in. In completion tools, the company's stage count increased by 38% versus a 22% rise in completions well count in the US, per EIA's estimates. The company's dissolvable plug sales (Stinger unit) increased by 42% in 2022. NINE had ~20% of the US plug market in 2022.

The other fundamental change for NINE has been the ESG initiatives in which it converted two hydraulic wireline units to electric. Moreover, it has committed to converting four more in 2023. The electrification of wireline units brought in the advantages of additional savings, while the dissolvable plug significantly reduces greenhouse gas emissions.

Also, the dissolvable pump down ring is estimated to reduce horsepower requirements by 48%. In this context, investors may note that the US frac spread count has strengthened in the US since 2023. The active frac spread count went down ~10% by the second week of April, according to Primary Vision's estimates. It appears the completions market will not display any sharp movement in the near term.

What's The Q1 Outlook?

In Q4 2022, the management sounded less optimistic about a recovery, particularly on the margin front. It expects revenues to decrease marginally (by 2.5%) in Q1 2023 compared to Q4 2022. Operating margin will decline from the Q1 and Q2 2022 levels (it recorded 8% and 12% adjusted EBITDA margin in those quarters, respectively).

Because of the warmer temperature in January and February, the demand for natural gas has fallen precipitously, which can lead to a margin degradation year-over-year. Still, the management does not foresee any steep decline in margin. Instead, it can decrease marginally and then back up in 2H 2022.

What Were The Recent Drivers?

In Q4 2022, the company's total revenues remained nearly unchanged compared to Q3. Division-wise, its cementing revenues increased by 3% quarter over quarter in Q4. Although cementing jobs decreased by 6%, the average blended revenue per job increased by 8%, offsetting the adverse effects.

In Completion tools, revenues increased by 13% in Q4. Despite that, the average blended day rate increased. The revenue growth in the Coiled Tubing business was steady (8% up quarter-over-quarter) in Q4. Coiled tubing utilization during Q4 was 56%.

Cash Flows And Debt Restructuring

As of December 31, 2022, NINE had $84 million in liquidity. Its shareholders' equity, which has been negative owing to significant net losses, has recovered in 2022 as a small net income lessened negative shareholders' equity. However, its balance sheet is still substantially risky and may limit growth prospects.

In FY2022, NINE's cash flow from operations (or CFO) and free cash flow (or FCF) turned positive compared to a negative CFO a year ago. In FY2023, the management estimates $30 million in capital expenditures. At the start of FY2023, it restructured debt. It refinanced a debt expiring in 2023 with debt maturing in 2028. It also extended its asset-based revolving credit facility to January 2027. As we advance, the company plans to de-lever further through free cash flow generation.

Target Price And Relative Valuation

NINE's forward EV/EBITDA multiple contraction versus the current EV/EBITDA is less steep than its peers, typically resulting in a lower EV/EBITDA multiple than its peers. This is because the company's EBITDA is expected to rise less sharply than its peers. The company's current EV/EBITDA multiple (6.4x) is in line with its peers' (NBR, PUMP, and OIS) average (6.3x). So, the stock is overvalued compared to its peers at this level.

According to data provided by Seeking Alpha, one analyst rated NINE stock a "buy" in the past 90 days (including "Strong Buy"), while one recommended a "hold" and none rated it a "sell." The consensus target price is $13.8, which yields 162% returns at the current price.

What's The Take On NINE?

As the energy indicators move sideways in early 2023, the fracking equipment market will have a sedate period soon. Despite the initial hiccups from the natural gas market and demand side uncertainty, which will keep its nose above the water, is the long-term effect of equipment undersupply, insufficient capital for investment, and labor market constraints. All these factors combined, NINE will continue to price traction in a tight market. In Q1 and 2023, the company plans to build on market share gains through higher efficiency in its various businesses. It has committed to converting four hydraulic wireline units to electric in 2023. So, its operating margin will likely improve in 2023. As a result of these positive developments, the stock price outperformed the VanEck Vectors Oil Services ETF ( OIH ) in the past year.

However, in Q1 2023, it faces ample headwinds from warmer temperatures and significantly lower demand for natural gas and prices. The issues can lead to a softer topline and margin contraction in Q1. Investors should also note that the company has a significant market share in the dissolvable plugs market. On a more positive note, NINE's cash flow generation turned positive in FY2022. At the start of FY2023, it refinanced a debt expiring in 2023 with debt maturing in 2028 and extended its asset-based revolving credit facility. The debt restructuring is critical given the company's negative shareholders' equity. Given the stock's relative overvaluation, investors can hold on to it for a steady medium-term return.

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