WFRD - Weatherford International: Strong Near-Term Outlook With Further Margin Expansion Potential

2023-08-06 07:42:19 ET

Summary

• I recommend WFRD as a buy due to my expectation of strong EBITDA growth.
• WFRD's Middle Eastern operations and multi-year contracts support the projection of double-digit revenue growth in 2024.
• Ongoing investments in infrastructure, technology, and human capital management indicate the potential for higher margins and growth opportunities.

Investment action

Based on my current outlook and analysis of Weatherford International ( WFRD ), I recommend a buy rating. I expect to see strong EBITDA growth in the next few quarters, backed up by strong revenue growth and a higher incremental margin driven by internal initiatives. WFRD should also see its valuation improve due to its strong near-term outlook and better margin profile than peers.

Basic recap

WFRD provides oil field services and equipment. The Company offers drilling solutions, gas well unloading, restoration, and other related activities.

Review

WFRD reported another strong quarterly performance and raised its guidance for FY23 for the second consecutive quarter. The increased visibility of WFRD's Middle Eastern operations is a key factor in the company's projection of double-digit revenue growth in 2024. Multi-year contracts recently awarded by regional national oil companies provide strong evidence to back up management's optimism. This faster revenue growth, in my opinion, should drive margin expansion in 2024 and possibly in 2025, thanks to operating leverage and the premium pricing opportunity in specialized services. There is a reason behind my high expectations. Over the past two years, as revenue has rebounded from COVID lows, WFRD's incremental margins have trended between 30 and 40%. As such, with double-digit growth potential in the coming quarters, we should see margins further expand.

In fact, I think WFRD could boost its incremental margin even more. In order to increase its operational ability, the company is continuing to invest in areas such as modernizing its infrastructure, implementing a new logistics system, and enhancing its human capital management. Management has also emphasized its continued investment in a variety of technologies as a means of keeping it at the forefront of its field. I think the company's emphasis on technological differentiation will first help it improve productivity, thereby driving margin expansion, and also potentially help it gain market share in adjacent markets. While it may be challenging to put a precise number on the results of such investments right now, I am hopeful that they will pave the way for sustainable gains in margin as the business moves forward.

Balance sheet/capital return

The company's balance sheet is still in good shape, with net debt/EBITDA at around 1x. On the 3Q23 earnings call, management stressed the importance of maintaining a healthy balance sheet. To improve operational flexibility in its borrowing base, I anticipate that management will continue to use free cash flow for this purpose. WFRD currently has a net debt of around $1.4 billion. Consensus is expecting WFRD to generate around $280 million of FCF in 2H23 and $520 million of FCF in FY24, for a total of $810 million. This would bring down the net debt to a figure of $600 million by FY24, which translates to 0.5x net debt to EBITDA by then. This balance sheet profile is extremely favorable in the current high rate environment, in my opinion, as it allows management to invest in CAPEX aggressively (recall the investment in tech) and at the same time pay out dividends. While WFRD has not paid out any dividends so far, with this improved balance sheet, I think there is potential for it.

Valuation

I believe WFRD can continue its strong revenue growth from 1H23 onwards to 2H23, leading to a high teens growth rate. The signing of new agreements in the Middle East also boosts my confidence that FY24 will see potential double-digit growth as well (as mentioned by management). I valued WFRD at 7x forward EBITDA, as I expect it to close its gaps vs. peers that are trading at a median of 7.8x forward EBITDA. While I acknowledge that WFRD has a lower expected EBITDA growth rate, other aspects of the business are relatively better than some of its peers, like gross and EBITDA margin. Moreover, we have pretty high visibility into WFRD's near-term outlook.

Final thoughts

I am favorable to WFRD's positive near-term outlook and potential for further margin expansion. The company's impressive quarterly performance, increased visibility in the Middle East, and the awarding of multi-year contracts support the projection of double-digit revenue growth in 2024. The historical trend of incremental margins between 30 and 40% and ongoing investments in infrastructure, technology, and human capital management indicate the potential for even higher margins. With a healthy balance sheet and improving operational flexibility, WFRD is well-positioned to invest in growth opportunities while potentially considering dividends.

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