RES - Shifting Sands: RPC In A Volatile Oil Market

2023-06-17 07:55:10 ET

Summary

• RPC has experienced strong revenue and earnings growth.
• But declining rig count and fluctuating oil prices may challenge its continued earnings expansion.
• It may be prudent to exercise caution for now.

Introduction

Investing can be a rollercoaster ride. When the landscape shifts, and even the most promising stocks can turn sour. That's why it's crucial to keep a close eye on the business climate and watch for any signs of dark clouds on the horizon. Now, speaking of a changing climate, let's turn our attention to the oilfield services provider RPC (RES).

On the surface, it looks like RPC has hit all the right boxes. The company has delivered solid revenue and earnings growth. Just what an investor would hope to see. But, look a bit closer, and you'll notice there's a storm brewing on the horizon of the oilfield services industry. Two critical metrics, those pillars that shape the fate of oilfield service providers, are showing signs of wear and tear, both heading down a path we'd rather not see them go. This situation is casting a bit of a shadow over RPC's near-term prospects. Just a few months back, everything seemed better. Now, though, things are starting to look a tad more gloomy.

Earnings Growth

Beginning with a quick overview of RPC's performance this year, the company managed to generate revenues of $476.7 million in the first quarter , reflecting a significant 67.5% increase compared to the same period the previous year. Notably, both the Technical and Support Services segments reported remarkable growth in earnings. The operating profits of the Technical Services leaped to $103.5 million from $21.8 million, while Support Services saw its operating profits rise to $6.7 million from $2.8 million during the same period last year. Concurrently, the company's adjusted EBITDA skyrocketed by 209% year-over-year to $132.9 million, and its adjusted net income grew by a multiple of 5.5 to reach $0.39 per share.

I believe RPC has skillfully capitalized on the vibrant business climate, which has seen a surge in the demand for oilfield services. Despite a decline in the WTI oil price, which averaged $76 a barrel in Q1-2023 compared to $94 a barrel in Q1-2022, the prevailing price levels, coupled with the commodity's outlook, provided the oil and gas rig operators the confidence to sustain high levels of drilling activity. According to data from Baker Hughes, the number of oil and gas rigs in operation averaged about 760 in the US in Q1 2023, marking a substantial increase from roughly 630 previously.

In the face of heightened drilling activity, the demand for well completion and other oilfield services remained robust, allowing RPC to raise its prices. The company expanded its revenue-generating fleet of equipment in response to high levels of customer activity, a strategic move that significantly contributed to its revenue and profit growth.

Dark Clouds Ahead

WTI oil prices largely ranged between $75 and $80 a barrel during the first quarter of 2023. Slowing growth in developed economies raised concerns about oil demand, but China seemed like a bright spot. China's recovery from COVID-19 lockdowns was anticipated to push demand higher. However, this projected demand surge from the world's largest oil importer fell short. OPEC's decision to cut output, followed by Saudi Arabia reducing its July output by an unprecedented 1 million barrels per day, could not buoy oil prices, which hovered around $67 a barrel at the time of writing.

In my opinion, China's economic indicators for May have further exacerbated concerns. The country's industrial output growth slowed to 3.5% in May from 5.6% in April, signaling reduced demand from both local and international manufacturers. Consumer confidence also dipped, with retail sales growth decelerating to 12.7% in May from 18.4% in April. Additionally, the critical property market not only remained sluggish but also witnessed a massive 21.5% year-over-year investment decline in May. Exports and imports also fell by 7.5% and 4.5% respectively on a year-over-year basis in May, prompting the Chinese government to introduce stimulus measures. However, these concerning figures raise questions about the future demand for oil and could explain why oil prices have not risen, despite OPEC+'s supply cuts.

The American oilfield services industry might feel the impact of this weakness in the oil market in the near future. In fact, the drilling activity has begun to decline rapidly. Baker Hughes has now reported six straight weeks of rig declines. The US oil and gas rig count has fallen from 751 to 687 units in the second quarter. This retreat is probably a reaction from US oil and gas producers looking to control expenses and maximize shareholder returns in a weak and uncertain oil price environment. The number of operational oil and gas rigs in the US is now less than what it was during the same period last year (687 rigs on 6/16/2023 vs 740 rigs on 6/17/2022), indicating a negative year-over-year comparison that contrasts with the average first quarter numbers.

For RPC, this is cause for concern. The company, which has been enjoying robust revenue and earnings growth, may face challenges if the trend of declining rig count continues. Should oil producers continue to withdraw rigs and the demand for oilfield services weakens, RPC's earnings growth could potentially be affected.

It's not impossible that oil prices could recover in the coming months, especially if China's economy responds positively to the stimulus measures recently introduced by the Chinese central bank. The bullish oil thesis could also be supported by the US Federal Reserve's decision to pause interest rate hikes and supply cuts from OPEC+. However, any potential increase in oil prices may not immediately translate into increased drilling activity due to a lag effect. As a result, even if oil prices begin to improve in the second half of 2023, RPC may still face a challenging business environment.

This is not to suggest that RPC is navigating a particularly perilous situation or that the demand for oilfield services is plummeting. With current oil prices, oil producers can still maintain profitable operations and healthy drilling activity levels. However, the momentum in drilling activity we witnessed last year appears to be dwindling.

I think this assessment aligns with other industry forecasts, including a presentation by Schlumberger ( SLB ) stating that E&P spending in North America will begin to moderate from 2023 after consecutive years of rapid growth. This recent drop in the rig count likely reflects the moderation in spending. In such a climate, while RPC may continue to turn a profit, its earnings growth could slow, potentially impacting the company's shares adversely.

Takeaway

Despite RPC's impressive trajectory of rapid earnings growth, the current landscape of fluctuating oil prices and a decreasing rig count - indicative of softer drilling activity - may challenge the company's continued earnings expansion. This could negatively influence its stock performance. As such, it may be prudent to exercise caution and steer clear of this stock for the time being.

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