TOLWF - The Riskiest Investments In Oilfield Services

2023-03-10 10:55:25 ET

Summary

• Given economic uncertainty and volatility in energy markets, I believe cautious oilfield services investors will want to avoid the highest risk investments in the sector.
• 58 oilfield services providers were screened for profitability based on net income margin; 26 were not profitable over the previous twelve months.
• These 26 OFS equities were selected for further analysis and evaluated using a quality matrix based on valuation, profitability, free cash flow, and debt.
• Based on this evaluation, the highest risk oilfield services equities were identified.
• I recommend most investors avoid FTK, BORR, RIG, DWSN, DO, ENG, KLXE, NGS, ICD, and ENSV.

Please note, this analysis is the counterpart to a previous analysis wherein the highest quality oilfield services investments were identified using analogous methods.

Oilfield Services: Elevated Risk

On March 7th, the Federal Reserve restated the central bank's intentions to continue raising the Fed Funds Rate in its ongoing effort to reduce inflation. Although many believe the Fed will raise its key rate by 50 basis points at its next policy meeting, investors cannot be certain how oilfield services ((OFS)) equities will respond.

Further, since early June of last year, WTI has trended down from nearly $120/bbl to its more recent range of 75-$80/bbl.

WTI, XES, and OIH: Recent Price History

WTI crude oil, the SPDR S&P Oil & Gas Equipment & Services ETF (XES), and the VanEck Vectors Oil Services ETF (OIH) are shown above. While crude oil has declined for several months, XES, OIH, and many OFS providers have continued to climb. Further uncertainty could trigger a steep decline in OFS.

WTI Crude Oil Outlook

The US Energy Information Agency published its most recent Short Term Energy Outlook on March 7th, 2023.

WTI Spot Price

The EIA expects crude oil to continue on a shallow decline through 2023. Notably, EIA's confidence intervals are very wide.

Oilfield Services: Initial Screen

I actively monitor 58 OFS providers and routinely trade the sub-sector on quality, value, sentiment, momentum, and volatility. These providers are listed below and sorted by ascending net income margin.

OFS: Net Income Margin

The OFS providers highlighted in red were not profitable with negative net income margin reported over the last 12 months. These 26 equities are likely to include the riskiest investments in the sector and will be considered further below.

Oilfield Services: Quality Ranking

The unprofitable OFS providers were evaluated using a quality matrix with factors including Price/Sales, Net Income Margin, Free Cash Flow Margin, and Debt to Equity. The values for each provider's factors were normalized by means of statistical percent ranking with relation to the group. The quality matrix for each OFS provider was calculated as the sum of the percent rank of each factor.

OFS Providers: Quality Matrix Chart

The above chart and the plot below are sorted in descending order from the poorest quality (lowest matrix score) to the best quality (highest matrix score).

OFS Providers: Quality Matrix Plot

The quality matrix is presented graphically in the stacked bar chart to the left. Based on the initial screen and subsequent quality matrix, the riskiest OFS investments are Flotek Industries ( FTK ), Borr Drilling ( BORR ), Transocean Ltd ( RIG ), Dawson Geophysical ( DWSN ), Diamond Offshore Drilling ( DO ), ENGlobal ( ENG ), KLX Energy Services ( KLXE ), Natural Gas Services ( NGS ), Independence Contract Drilling ( ICD ), and Enservco ( ENSV ).

Matrix Limitations

Investors should consider the quality matrix a screen only. The matrix, its factors, normalization method, and weights could all be adjusted and yield different results. Further, the matrix is based on the most readily available and common metrics. Some of these metrics will change rapidly with share price while others will change as new company reports are released. It does not include company-specific data available in quarterly reports and presentations. Every investment decision regarding an individual equity should be based on comprehensive analysis of that equity.

Conclusions and Recommendations

I recognize that some investors will not like my approach. Some readers may have a high risk tolerance or have a well thought investment theses that includes high risk. Some readers will be eager to let me know why I'm wrong; I look forward to hearing all about it in your comments.

However, I recommend most investors avoid FTK, BORR, RIG, DWSN, DO, ENG, KLXE, NGS, ICD, and ENSV.

I recommend those investors who are comfortable in the sector focus on fundamentally sound companies who have recently produced profits and free cash flow. In a previous analysis, Oilfield Services: Screening And Matrix Evaluation, I identified several promising OFS providers using analogous methods.

Chance has little effect upon the wise man, for his greatest and highest interests are directed by reason throughout the course of life. - Epicurus, The Principal Doctrines

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