OIS - Oil States International: Driving Towards Profitability

Summary

• Shares of oil field services concern Oil States International have rallied sharply off mid-September lows but still are off some 25% from their yearly highs.
• Despite the recent stock price negativity, the company is expected to return to earnings profitability in FY23 for the first time since FY15.
• With Adj. EBITDA and revenue metrics returning to pre-pandemic levels for the first time in 2Q22, the recent insider buying merited a deeper dive.
• A full investment analysis follows in the paragraphs below.

Today, we take our first look at an oil services firm approaching profitability for the first time in years. An analysis follows below.

Company Overview:

Oil States International, Inc. ( OIS ) is a Houston-based provider of products and services employed in the drilling, completion, subsea, production, and infrastructure segments of the oil and gas industry, with further applications in industrial and military verticals. Its domestic operations primarily support the oil shale industry, whereas its international business supports deepwater/offshore drilling activity. Oil States was founded in 1937 as an oilfield supply store and has grown through over forty acquisitions. It went public in 2001, raising net proceeds of $80.5 million at $5.14 per share, after giving effect to the 2014 spinoff of its accommodations business Civeo ( CVEO ) . Oil States stock trades at just under seven bucks a share, translating to a market cap of approximately $325 million.

Operating Segments:

The company evaluates its business through three operating segments: Offshore/Manufactured Products ((OMP)), Well Site Services (WSS), and Downhole Technologies ((DT)).

OMP provides highly-engineered products and services primarily for offshore oil and natural gas production, as well as land-based drilling, industrial, and military applications. Some of the equipment and services sold to the 'long-cycle' or mega-projects include deepwater mooring systems, cranes, subsea pipeline products, connector systems, welding, fabrication, cladding, and machining services, as well as installation, inspection, and repair. OMP also provides consumable downhole (casing and cementing) products to the North American shale vertical, as well as sound and vibration equipment for marine vessels and construction and maintenance products for offshore wind projects. OMP generated 1H22 operating income of $19.6 million on revenue of $180.6 million, up from $5.9 million on revenue of $137.5 million in the prior-year period. This segment's first half accounted for 52% of Oil States' topline and 60% of its Adj. EBITDA.

WSS provides completion (i.e., prepping a well for production) and drilling services - including wellhead isolation, frac valve, and downhole services, amongst others - predominantly to land-based oil shale exploration and production concerns in the U.S. This segment lost operating income of $2.8 million on revenue of $103.0 million in 1H22 versus a loss of $21.4 million on revenue of $81.6 million in 1H21. WSS contributed 30% of the company's topline and 29% of total Adj. EBITDA in 1H22.

DT harnesses the company's perforation technology to maximize the effectiveness of hydraulic fracturing by enabling optimization of perforation hole size, depth, and quality of tunnels predominantly for the domestic oil shale industry. This segment also provides toe valve and frac plug offerings for horizontal wells, as well as consumables primarily for completion applications. DT came via a $615 million acquisition of GEODynamics in 2018. In 1H22, this unit generated operating income of negative $3.0 million on revenue of $62.3 million as compared to a loss of $3.9 million on revenue of $52.2 million. DT was responsible for 18% of the company's revenue and 11% of its Adj. EBITDA in 1H22.

Also with regard to its 1H22 topline, Oil States derived 54% of it from well completion activities and 22% from longer cycle (usually offshore) project products and services, which are not as sensitive to commodity price volatility. The balance of the company's topline came from drilling services and other commercial and military applications.

Third Quarter Results:

On October 27th, the company reported third quarter numbers . Oil States International had a non-GAAP net loss of four cents a share even as revenues were up nearly 35% on a year-over-year basis to just over $189 million. Both sales and earnings results were roughly in line with expectations. The company's Offshore & Manufactured Products backlog increased 7% over the second quarter of this year and now stands at $258 million. Operating cash flow came in at a positive $29 million during the quarter.

Earnings Volatility:

Like most oil and gas services companies, Oil States is subject to the whims of commodity prices and the E&P industry's outlook on said prices, which dictate drilling activity and rig counts. The company's stock price peaked at $65.77 per share in 2014 when oil was above $100 per barrel and frac spreads - a de facto rig count-like measure for completions - were well above 400. Shares of OIS then traded lower for the balance of the decade with lower oil and gas prices, capitulating to $1.52 during the pandemic sell-off in March 2020 as the market rightly foresaw a dramatic drop in drilling activity, with frac spreads bottoming at 45 in May 2020. As such, Oil States went from earning $3.31 a share (GAAP) and Adj. EBITDA of $438.1 million on revenue of $1.82 billion in FY14 to losing $1.06 a share (GAAP) while generating positive Adj. EBITDA of only $38.1 million on revenue of $573.2 million in FY21. The company has not been profitable on a GAAP basis since FY15.

Energy prices have been volatile in 2022 for numerous reasons, including the war in Ukraine. Not helping matters is the current administration's combative stance towards the oil and gas industry. Who's going to put in the prerequisite midstream infrastructure when key political leaders are campaigning on ending fossil fuels? Additionally, ESG lobbying efforts to curtail investment have been another headwind for the industry.

Balance Sheet & Analyst Commentary:

During the third quarter, Oil States paid $10 million in cash and issued approximately 1.9 million shares of its common stock (having a market value of $10.3 million) to fully settle the $17.5 million promissory note payable (together with related accrued interest of $2.2 million) and resolve outstanding legal disputes with the seller of GEODynamics, Inc. The company ended the third quarter with approximately $33 million of cash and marketable securities on its balance sheet. The Company's total debt represented 19% combined total debt and stockholders' equity as of the end of the quarter. Liquidity (cash plus borrowing availability) stood at $113 million as of the end of September.

The only Street analyst who has made public commentary on Oil States in the past twelve months is Ian Macpherson at Piper Sandler, who upgraded shares of OIS from a hold to an outperform on valuation back in March. He subsequently raised his price objective from $8 to $10 in April, citing the improving environment in the oil patch. On average, the Street expects the company to lose $0.15 a share on revenue of $740 million in FY22, followed by a gain of $0.33 a share on revenue of nearly $845 million in FY23.

Recently onboarded COO, Philip Scott Moses, is in accordance with Macpherson's assessment, acquiring 58,624 shares at an average price of $3.63 on September 26th, 2022.

Verdict:

Geopolitical developments and questionable domestic energy policies conspired to drive commodity prices substantially higher, which has put a little wind in Oil States' financial sails. However, as the global economy stumbles into recession, the best-case scenario - higher energy prices leading to increasing frac spreads - looks as if it has already passed, with Oil States yet to return to profitability.

Even if the Street is correct and the company earns $0.33 a share in FY23, that translates to a forward PE of over 20, not particularly cheap given the industry's volatility and the elevated interest rate environment. The bet here is that a likely global recession will eventually act as a further drag on energy prices. As such, investment in OIS is not recommended at this time.

"Democracy is a pathetic belief in the collective wisdom of individual ignorance. " - H.L. Mencken

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