SOI - Oilfield Services Conundrum: Solaris Oilfield Infrastructure Shines Bright

2023-06-28 14:59:25 ET

Summary

• Solaris has experienced significant growth in the past, driven by a surge in U.S. oil and gas drilling activity in response to high commodity prices.
• The current market conditions are challenging, with oil and gas prices experiencing weakness and volatility, leading to a decline in the number of onshore rigs in the US.
• Despite tough market conditions, Solaris is well-positioned to weather the storm due to three key reasons.

Navigating the oilfield services market these days is no walk in the park. If you've been following my articles ( here and here ), you know how the sinking rig count in the US has cast a rather gloomy shadow on many companies in this space. Sure, almost all US-centric businesses are feeling the heat, but don't lose hope just yet. I believe there are some bright spots that can handle the heat a bit better. Let's talk about Solaris Oilfield Infrastructure ( SOI ), for instance. Much like its counterparts, it's grappling with a tough outlook. But here's my two cents - it stands a stronger chance of weathering the storm. Why, you ask? Well, in this piece, I've outlined three key reasons. So, keep your eyes peeled for Solaris Oilfield Infrastructure - it's one stock I'd highly recommend you keep tabs on.

Robust Growth

Solaris Oilfield Infrastructure offers a broad spectrum of products and services aimed at enhancing well-site performance. The company's clientele includes major oil and gas producers such as EOG Resources ( EOG ) and oilfield service providers like Halliburton ( HAL ), to whom they provide support during the completion phase of oil and gas wells.

Solaris is particularly renowned for its well-site sand handling equipment, carving a niche for itself in the industry. Its core competencies include the development of electrical machinery capable of moving and blending sand and liquids. Besides mobile proppant management systems, the company provides logistics management services, top fill equipment, integrated electric blenders, and fluid management systems.

With operations spanning all the major U.S. shale plays, including the Permian Basin in West Texas and Southeast New Mexico - the hotbed of U.S. shale activity - Solaris' reach also extends to Eagle Ford, the Bakken formation, Haynesville, STACK/SCOOP, and Marcellus regions. The company manufactures its specialized equipment at a 100,000 square foot facility located in Early, Texas.

Over the past year, Solaris has demonstrated remarkable growth, fueled by a rise in U.S. oil and gas production in response to soaring oil and gas prices. In 2022, the average spot WTI oil price surged 39.3% from the previous year to nearly $95 per barrel. Concurrently, the Henry Hub natural gas price climbed by 66% from a year earlier, reaching an average of $6.45 per MMBtu. As a response to this bullish price environment, U.S. shale drillers significantly amplified drilling activities, adding 191 rigs - an increase of 33% from 2021.

Consequently, Solaris experienced heightened demand for its products and services. The company's revenues doubled to $320 million in 2022 , and it reversed its net loss of $0.04 per share in 2021 to report a profit of $0.64 per share. The growth momentum persisted into the first quarter of 2023, with Solaris reporting a 45% year-over-year surge in revenues to $82.7 million and a near doubling of its profits to $0.23 per share.

Challenging Path Forward

However, the business landscape appears increasingly daunting, influenced primarily by the volatility in commodity prices. In contrast to the previous year, both oil and gas prices are facing downward pressure in 2023. The WTI oil price has primarily remained within the $70 to $80 per barrel range throughout the year and currently stands at $69.94, which is notably lower than the previous year's average of nearly $95. Concurrently, natural gas prices have plummeted from $3.27 in January to $2.24 per MMBtu. In response to this uncertain and weak commodity price environment, oil producers have started to gradually withdraw oil and gas rigs as they shift their focus towards maximizing shareholder returns.

Consequently, the oil and gas rig count has begun to steadily decline. According to data from Baker Hughes, there were over 770 operational rigs in the U.S. at the beginning of the year. However, this number fell to 682 by the end of last week, reflecting a drop of more than 11.7%. This declining trend could pose challenges for oilfield services and equipment providers like Solaris.

It's important to note that Solaris predominantly operates in onshore shale oil and gas plays, which have been most affected by the decline in drilling activity. The onshore rig count has decreased by 12.3% this year to 663 rigs, while the offshore rig count has maintained a steady range of 19-20 units since mid-April.

Data Source: Baker Hughes (link provided earlier)

Data Source: Baker Hughes (link provided earlier)

The potential reduction in oil and gas producers' spending, coupled with the continuing removal of rigs and decreased well completion activity, could lead to a slump in demand for Solaris's products and services. While improved pricing has led to an increase in the company's margins, especially in 2023, a decline in demand could exert downward pressure on these margins, and consequently, its earnings.

Signs of Resilience

Indeed, the current business environment for oilfield service and equipment providers does not match the optimism of the previous year. However, in my view, Solaris stands as a company that could potentially fare better than others due to three key reasons.

Firstly, as oil and gas producers pivot towards enhancing their returns, Solaris is well-positioned with its suite of products and services that facilitate exactly this. Its innovative sand delivery solutions assist customers in cost reduction and efficiency improvement at well sites. This is reflected in the growing acceptance of its new top fill technology, which continues to be adopted by oil and gas producers due to its efficiency improvements and cost-saving capabilities. Similarly, the company's new AutoBlend Integrated Electric Blender aims to supplant traditional blenders, thereby reducing maintenance and operating costs, including personnel requirements, and improving equipment uptime.

Secondly, the launch of new products, specifically the top fill and AutoBlend systems, also fuels the optimism around Solaris's potential performance. The top fill technology's popularity can be evidenced by the fact that in Q1-2022, around 1% of the company's sand systems used this technology. However, fast-forward to 2023, and now 25% of the sand systems have adopted this new kit. Solaris anticipates this positive trajectory to persist. The AutoBlend system is also growing in popularity and has enabled the company to operate five to six blenders simultaneously, compared to two to three blenders previously.

These new products - the top fill and AutoBlend systems - have already positively influenced Solaris's earnings, and this trend could likely continue into the future. I foresee the adoption of these new technologies greatly helping to offset the adverse impact of a weakening market.

Thirdly, Solaris boasts an excellent financial health, which bolsters its capacity to weather any market instability. The company has no long-term debt and has borrowed $26 million from the $75 million revolving credit facility. Solaris also has cash of $2 million. This indicates that the company has approximately $51 million of liquidity ($49Mn from the credit facility + $2Mn in cash), which is a healthy buffer for Solaris. The company anticipates funding its capital expenditures (estimated to be $65 million to $75 million this year) from operating cash flows. Notably, the company ended the first quarter with negative $2 million in free cash flows, primarily because its capital expenditure plans are heavily weighted towards the first half of the year. As these investments decrease in the latter half of the year, I expect to see a meaningful surge in free cash flows, further strengthening its liquidity position.

Final Thoughts

Without a doubt, this year is presenting a set of challenges for Solaris. On one hand, we've seen a surge in revenues and earnings, as the first quarter results clearly demonstrate. On the other hand, its shares have experienced an 18% decline as investors prepare for the ripple effects of the current market conditions. I anticipate that these shares will remain under pressure in the near term as the business environment remains challenging and as oil and gas drillers persist in decommissioning rigs.

For now, it would be prudent for investors to adopt a cautious approach. However, Solaris is a stock worth closely monitoring. In my view, Solaris is more resilient than other oilfield service companies in the face of these challenging market conditions. I believe its revenues and earnings might remain resilient during this downturn, and in the long term, when the market experiences an upturn, the company is likely to bounce back strongly. Consider making an investment once we start seeing signs of a turnaround. I will continue to monitor this sector closely, and I recommend that investors do the same.

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