WFRD - Weatherford: Expect To Benefit From A Macro Turnaround And Operation Initiatives

2023-05-02 09:02:00 ET

Summary

• WFRD had a strong start in 1Q23 with adjusted EBITDA of $269 million, exceeding consensus.
• Management raised full-year guidance for revenue, EBITDA, and FCF.
• Management's ongoing efforts to optimize operations will lead to improved margins and better management of their balance sheet, ultimately resulting in better conversion of FCF.

Thesis

Weatherford International Public Limited Company ( WFRD ) is an equipment and service provider for the oil and gas industry. Their offerings include drilling solutions, gas well unloading and restoration, and more. WFRD is off to a strong start in 1Q23 , with management raising full-year guidance due to growth in operations, EBITDA margin, and FCF conversion. I recommend a buy rating for WFRD as it is well position to benefit from a macro turnaround, supported by its internal operation improvements. Regarding the first point, WFRD plays a crucial role in offshore drilling and has leading market share in Managed Pressure Drilling and Tubular Running Services. This enables them to generate revenue with strong growth potential due to the high rate of activity. With regards to internal operations, I believe that the management's ongoing efforts to optimize operations will lead to improved margins and better management of their balance sheet, ultimately resulting in better conversion of FCF. The strengthening of the balance sheet also paves the way for the distribution of surplus capital to stockholders.

1Q23 results

WFRD's $269 million in adjusted EBITDA for 1Q23 was significantly higher than the $224 million predicted by consensus. EBITDA margins and revenue growth that exceeded projections were primary contributors to the variance. The FCF of $27 million was fueled by higher than expected cash flow from operations. One notable event during the period was the repurchase and repayment of $62 million in senior notes by management. Of this amount, $20 million was the 11% Exit Notes. Management also disclosed that the remaining $105 million in 11% Exit Notes would be redeemed.

Guidance is focus

For 1Q23, I believe the emphasis was placed on the guidance. After a successful first quarter, management increased their projections for the full year's revenue, EBITDA, and free cash flow. My confidence for the FY23 numbers is strong given the leading indicators that management noted (such as sustained field execution and robust tendering activity). Consequently, consensus has increased their earnings estimates for FY23 (from $4 EPS to $4.66, a 17% increase) as a result of this higher guidance, which, in my opinion, is a textbook example of the "beat and raise" playbook. If we look at consensus guidance historically (since mid 2022), the playbook for the stock seems to be a revision in estimates after every earnings (which drove the stock 1 way up). Based on this trend, if WFRD can continue to execute, we could see a similar trend.

Margin profile

With management's increase in FY23 margin guidance, I see a clearer path for WFRD to achieving its long-term EBITDA margin target (mid-20%). In my opinion, higher activity levels and better incremental margins are both necessary for this margin improvement to materialize. I anticipate that the Drilling and Evaluation division's long-term margin profile will be higher than the WFRD consolidated long-term EBITDA margin target. This, I believe, is due to the company's dominant market share in the Managed Pressure Drilling industry, which in turn generates higher pricing power and higher incremental margins as a result of the company's differentiated service offerings. The Middle East and Latin America are also anticipated to be major drivers of international activity. I think WFRD will benefit significantly from this growth because it is anticipated that a sizeable percentage of it will originate offshore in both regions where managed pressure drilling is essential.

FCF profile

It's encouraging to see management focusing on the balance sheet in addition to the P&L to boost shareholder returns. In my opinion, management is taking a positive step toward enhancing FCF conversion by repaying and redeeming a portion of its outstanding debt. When it comes to FCF conversion, I believe there is definitely still room to improve (from the current 30+%) as management targets a 40 to 50% conversion rate. The first and immediate visible improvement to FCF conversion rate is after the paydown of debt, which will have a clearer impact on an annual basis. Many shareholders, including myself, are probably eagerly awaiting WFRD's return of excess capital to shareholders. Prior to considering a return of capital, I would rather see WFRD continue to strengthen its balance sheet by concentrating on reducing debt, and reinvestment into the business. These actions take priority as it ensures the longevity of the business, which is more important than short-term returns, in my opinion.

Conclusion

WFRD has had a strong start in 1Q23, with better than expected results and increased guidance for the full year. I recommend a buy rating with the expectation that the business will outperform on two reasons. First is their critical role in offshore drilling and internal operations improvements, which makes it well-positioned to benefit from a macro turnaround. Second is management's ongoing efforts to optimize operations, which I expect to lead to improved margins and better FCF conversion.

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