OIS - Oil States International Gets Close To An Inflection Point

2023-10-11 14:12:36 ET

Summary

• OIS is experiencing growth in offshore and international drilling operations, but faces a slowdown in the US market.
• The company is expanding into subsea minerals, renewable, and clean tech energy systems.
• OIS' backlog is growing, indicating medium-term growth potential, but limited short-term room for stock growth.

OIS Gains Momentum

I have been discussing Oil States International ( OIS ) in the past, and you can read the latest article here . The primary pivot for OIS is the inflection in the offshore and international drilling operations, even though drilling and completion spending have lowered in the US. To participate in this fast-growing industry, it has forayed into the subsea minerals, renewable, and clean tech energy systems. The company’s growing backlog validates the medium-term growth potential.

However, in the short term, it will continue facing the slowdown of the US drilling and fracking market. It lost a few large customer projects in the Northeast and the Gulf of Mexico, while third-party intervention vessels went temporarily out of service due to dry docking. The company’s cash flows improved remarkably in 1H 2023. The stock is relatively undervalued versus its peers. Still, given the stock price’s steep rise over the past year, I think it has limited room to grow in the short term, so I suggest investors “hold” it.

Industry Outlook

OIS will continue to offer to two sets of customers. One belongs to the traditional subsea, floating, and fixed production operations and the military customers. The offshore industry has shifted from a low-demand scenario to an inflection upward in international and offshore markets.

However, expectations for growth in drilling and completion spending have lowered in the US. This can affect OIS’s growth potential adversely in this region. More recently, crude oil prices have started to go north, accelerating shorter-cycle US investments. Globally, investments in long lead-time projects are on the rise. This is expected to usher in a multiyear upcycle in the energy business.

Strategies And Upcoming Projects

The company has started expanding its product offerings and revenue base. It has made strategic partnerships concerning subsea minerals collection systems, including subsea harvesters, flexible jumpers, deepsea minerals riser packages, and similar products. Recent additions include subsea minerals and renewable and clean tech energy systems, including fixed and floating offshore wind developments.

In September, OIS received a contract for its Merlin deepsea mineral riser system. It will harvest seabed minerals like cobalt, manganese, nickel, and rare earth elements used in EVs and the software industry.

Backlog Growth And Outlook

Given the abovementioned industry trend, OIS’s Offshore/Manufactured Products segment revenues can grow in 2H 2023. In Q2, the segment backlog increased by 4% sequentially and 40% year-over-year. With a 1.1x book-to-bill ratio and bookings totaling $106 million in Q2, the backlog looks robust to support medium-term revenue visibility. The company estimated the Q2 backlog is at its highest since Q4 2015. Its short-cycle product demand remains resilient. However, in Q2, customer order delays affected the topline. As a result, I do not see the revenue and margin improving sharply in Q3, but its financial performance can turn around in Q4 in my view.

The company’s Well Site Services and Downhole Technologies segments results will reflect the US onshore market slowdown in the near term. However, the deceleration appears to be nearing an end, and I expect a turnaround in early 2024. It will focus on its core areas of expertise and provide differentiated products and services. In doing so, the company will optimize its operations and pursue profitable activity, both domestically and internationally.

Analyzing Q2 Performance

In Q2 2023, the Offshore Manufactured Products segment revenues decreased by 7% quarter-over-quarter. Despite lower revenues, the adjusted EBITDA remained nearly unchanged in Q2. Adverse timing of material receipts and contractual delivery terms led to lower revenues. The growth in backlog, however, can mitigate the revenue losses in the coming quarters.

The Well Site Services segment also witnessed a 4% lower revenue in Q2, while its adjusted EBITDA declined sharply, by 13.6%, during this period. The loss of larger customer projects in the Northeast and the Gulf of Mexico resulted in poor performance in Q2.

The Downhole Technologies segment saw the steepest sequential revenue fall (by 20%) in Q2 2023. Adjusted EBITDA also dipped (40% down) during this period. During Q2, various third-party intervention vessels went temporarily out of service due to dry docking. This significantly affected the segment results. However, international sales and customer activity improved during the quarter.

A Margin Analysis

In Q2, OIS’s adjusted EBITDA margin expanded to ~17% from 16.2% a quarter earlier despite 6% lower revenues. In Q3, the company believes it can hold or improve the EBITDA margin based on a higher share of products with better margins and an increased backlog. It can also benefit from third-party pass-through revenues. So, its margin should stay resilient in the coming quarters.

Cash Flows And Debt

In 1H 2023, OIS's cash flow from operations improved handsomely and turned positive, primarily due to higher revenues in the past year. Free cash flows (or FCF) also turned positive in 1H 2023. OIS's debt-to-equity ratio was 0.19x as of June 30, 2023, while the net debt-to-adjusted EBITDA was 1.2x. It had $167 million in liquidity as of that date. The company expects to invest ~$28 million in capex in FY2023, although market conditions will dictate the final decision.

What Does The Relative Valuation Tell Us?

OIS's forward EV/EBITDA multiple contraction versus the adjusted EV/EBITDA is steeper than its peers because its EBITDA is expected to rise more sharply in the next year. This typically results in a higher EV/EBITDA multiple than peers. The company's EV/EBITDA multiple (8.4x) is lower than its peers' (OII, NR, and FTI) average. So, the stock is undervalued at this level compared to its peers.

The stock’s past five-year average EV/EBITDA is 12.9x. So, it is trading at a discount to its past average. Given the mix of a dim outlook in the US and a prospering environment in the global market, I do not see the stock improving sharply in the short term. However, if it trades at the past average in the medium term, it can climb 65% from the current level.

Analyst Target Price And Rating

According to Seeking Alpha , three analysts rated OIS a "buy" in the past 90 days (including "Strong Buy"), while two recommended a "hold." None ranked it as a "sell." The consensus target price is $9.8, which yields ~18% returns at the current price.

Why Do I Keep My Call Unchanged?

I did several iterations of my analysis about OIS in the past. The common themes that cut across the analysis are the company's performance, positive outlook on the shorter-cycle onshore projects, and backlog stability. On the other hand, the perforating equipment sales in the US have dwindled as energy capex fell sharply. The other teething concern was the cash flow depletions in the past.

In my previous article, I signaled the opportunities in the traditional subsea floating and fixed production systems. The company’s interest was shifting toward fixed and floating offshore wind developments, subsea minerals gathering, and other renewable and clean tech energy systems. However, the natural gas price decline and negative cash flows kept pestering. I wrote :

Higher frac spread utilization has improved the profitability criteria in OIS's Well Site Services and Downhole Technologies segments. It recently reaped the benefit of winning a few awards in the Managed Pressure Drilling equipment division. The demand for perforating products in the international markets kept its backlog high.

After Q2, OIS sees an inflection in international and offshore markets. Its backlog has also remained steady. However, drilling and completion spending has lowered in the US. The significant change has been the cash flow turnaround in 1H 2023. Given the near-term US energy market slowdown and the long-term potential to proliferate globally, the stock remains apt for a “hold.”

What’s The Call On OIS?

I see a multiyear upcycle in the global energy business, which will benefit the long lead-time projects. Although the US rig and frac counts declined in 1H 2023, they can potentially see an uplift in 2H 2023. With more than half of its revenues coming from international and offshore markets, OIS’s recent orders strengthen its strategy of diversifying into subsea minerals and renewable and clean tech energy systems. So, the stock outperformed the VanEck Vectors Oil Services ETF ( OIH ) in the past year.

On the other hand, OIS’s Well Site Services and Downhole Technologies segments will likely be affected by the US onshore market slowdown in the near term. Nonetheless, the growth in backlog can mitigate the revenue losses in the coming quarters. The company made considerable strides in improving its cash flows. Its leverage is also low. Given the relative valuation, I expect returns from the stock to get better in the medium term, justifying my “hold” recommendation.

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