OIS - Oil States International: Long-Term Opportunities Trump Short-Term Drawbacks

2023-05-12 05:39:42 ET

Summary

• Oil States seeks further opportunities in the traditional subsea floating and fixed production systems.
• In Q1, its Manufactured Products segment backlog increased by 6% with a book-to-bill ratio of 1.2x.
• Lower natural gas prices affected the US onshore drilling and completion spending decisions and lowered demand growth.
• Cash flows were negative in Q1, although its debt-to-equity was low.

OIS To Tread Lightly

I discussed Oil States International's ( OIS ) strengths and weaknesses in my previous article . When the energy prices remain volatile in the current environment, OIS looks to bid on opportunities in the traditional subsea floating and fixed production systems. Higher demand for completions-related activity, especially the increased share of higher-margin perforating product sales in the international markets, kept its backlog high.

But OIS cannot escape the landscape where lower natural gas prices compromised the US onshore drilling and completion spending and the lower demand growth expectations. Plus, the reliance on perforating product sales is questionable because of the availability of various alternative products. In Q1, the company's cash flow from operations remained negative, which can also be a concern for investors. Although its leverage is low and the stock is undervalued, considering all the aspects, I think it would be prudent for the investors to hold back from making further investments in the stock.

The Industry Outlook

In the Q1 earnings call, OIS's management acknowledged the short-term pressure on energy prices. Demand concerns over crude oil and the effect of high storage on natural gas prices have kept prices range-bound in the past few months. In response, the energy companies in the US accelerated shorter-cycle investments. OIS also expects flat US production and increased demand for natural gas or LNG feedstock to lead to higher natural gas prices over the medium-to-long term.

Understanding The Strategy

In this environment, OIS looks to bid on opportunities in the traditional subsea floating and fixed production systems. These opportunities include fixed and floating offshore wind developments, subsea minerals gathering, and other renewable and clean tech energy systems. This will benefit the company's Offshore Manufactured Products segment. In Well Site Services, it plans to optimize its operations in the US and internationally. It will enhance completions equipment to differentiate its completions service offerings.

The drilling and completion spending on US onshore activities have recently dwindled following lower natural gas prices and demand growth expectations. But the situation appears to be recovering fast in international and offshore markets, which opens new opportunities for the company in the global market. The frac spread utilization improved over the last several quarters, which should favor its Well Site Services and Downhole Technologies segments. In the Offshore Manufactured Products segment, revenue growth can stay low in 1H 2023 but increase in 2H 2023. A firm order flow and increased backlog levels for short-cycle products can improve segment performance.

Backlog Increases

In Q1, the Offshore Manufactured Products segment backlog increased by 6% compared to Q4 2022. So, a total backlog of $326 million represented a book-to-bill ratio of 1.2x as of March 31, 2023. The Q1 bookings included three significant project awards (more than $5 million each), including several Managed Pressure Drilling equipment division awards.

The Q1 Drivers By Segments

In the Offshore Manufactured Products segment, quarter-over-quarter revenues decreased by 7%, and adjusted EBITDA plunged by 10% in Q1 2023. Adverse timing on certain project schedules led to lower revenues, although higher demand for short-cycle products mitigated some losses. However, as discussed above, a higher backlog can pull revenues in the coming quarters.

The Well Site Services segment witnessed nearly unchanged revenues in Q1 compared to the previous quarter. Adjusted EBITDA increased by 5.6% during this period. Higher demand for completions-related activity in the US and better equipment utilization resulted in the operating profit growth in Q1.

Revenues increased by 4% in Q1 2023 in the Downhole Technologies segment compared to Q4 2022. Adjusted EBITDA increased substantially during this period. An increased share of higher-margin perforating product sales in the international markets led to an improvement in the financial position of this region. However, investors may note that the international sales of perforating products are not uniform and can vary substantially in the coming quarters.

Cash Flows And Debt

In Q1 2023, OIS's cash flow from operations remained negative, although revenues increased in the past year. Free cash flows (or FCF) invariably were negative. A higher working capital requirement is customary in the year's first half. So, the management expects to generate higher free cash flow in 2H 2023.

OIS's debt-to-equity ratio was 0.20x as of March 31, 2023, while the net debt-to-adjusted EBITDA remained unchanged at 1.4x. It had $109 million in liquidity as of that date. The company expects to invest ~$25 million in capex in FY2023, which would be 25% higher than in FY2022.

What Does The Relative Valuation Tell Us?

OIS's forward EV-to-EBITDA multiple contraction versus the adjusted EV/EBITDA is steeper than its peers because its EBITDA is expected to rise more sharply than its peers in the next year. This typically results in a higher EV/EBITDA multiple than peers. The company's EV/EBITDA multiple (8.3x) is lower than its peers' (OII, NR, and FTI) average. So, the stock is undervalued at this level compared to its peers.

Analyst Target Price And Rating

According to Seeking Alpha , two 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 $11.2, which yields ~62% returns at the current price.

Why Do I Change My Call?

I put a "buy" rating on OIS in my previous article. The optimistic view was based on accelerated investment in shorter-cycle onshore projects based on higher demand for short-cycle products and relative undervaluation. I wrote :

OIS leverages its competencies in offshore wind developments, subsea minerals, and clean tech energy systems in shorter-cycle onshore deepwater projects. The company plans to optimize operations and pursue profitable activity through its differentiated service offerings.

Natural gas prices' long and dry spell cast doubts over OIS's investment decisions as it optimizes its operations in the US and internationally. While its value drivers have stayed on their course, the energy environment forced it to take corrective measures. However, the situation can improve from here, given the strong order flow and increased backlog levels for short-cycle products. Also, opportunities in the Well Site Services and Downhole Technologies segments can improve. So, I downgraded my call from "Buy" to "Hold."

What's The Take On OIS?

On the positive side, 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. So, the stock marginally outperformed the VanEck Vectors Oil Services ETF ( OIH ) in the past year.

But there are some roadblocks, too. Lower natural gas prices compromised the US onshore drilling and completion spending and the lower demand growth expectations. Adverse timing on certain project schedules also affected its topline in Q1. Free cash flows were negative in Q1. Its debt-to-equity is low, however. Investors would do well to "hold" the stock for higher returns in the medium term.

For further details see: