2023-04-25 12:02:12 ET
Summary
- PTEN has declined 15% since my last article on the stock.
- As a result, the stock is trading at a forward price-to-earnings ratio of only 7.0.
- PTEN will probably benefit from the recently announced production cut of OPEC and Russia.
- However, PTEN remains risky in the long run due to the secular threats facing its business.
About six months ago, I stated that business prospects were positive for Patterson-UTI Energy (PTEN) but the stock was risky from a long-term point of view. Indeed, since my article, the oilfield services provider has enjoyed favorable business conditions and thus it posted its first meaningful profit in the last eight years. In addition, OPEC recently announced another round of production cuts, which is likely to benefit Patterson-UTI Energy. Nevertheless, the rig count of Patterson-UTI Energy seems to be approaching a plateau while the company is also facing some secular threats in the long run. The stock has declined 15% since my article but remains risky from a long-term perspective.
Business overview
Patterson-UTI Energy provides oilfield services and products to U.S. and Canadian onshore producers of oil and gas. Its offerings include a diverse network of drilling and pressure pumping services, directional drilling, rental equipment and technology.
Patterson-UTI was severely hurt by the coronavirus crisis, which caused an unprecedented collapse in drilling activity in 2020. Due to the impact of the pandemic on its business, the company incurred losses per share of -$4.27 in that year. This amount of losses is 36% of the current market capitalization of the stock and hence it is excessive.
The global energy market began to recover from the pandemic in 2021 but the recovery was not sufficient to render Patterson-UTI profitable in that year. The company incurred a loss per share of -$3.36 in 2021.
On the bright side, the pandemic has subsided and hence drilling activity has returned close to pre-pandemic levels. In addition, Patterson-UTI has greatly benefited from the ongoing war in Ukraine. Due to the invasion of Russia in Ukraine, the U.S. and Europe have imposed strict sanctions on Russia. Before the sanctions, Russia was producing approximately 10% of global oil output and one-third of natural gas consumed in Europe. The sanctions caused a great deficit between supply and demand in the global oil market. As OPEC maintained strict production quotas in order to support the price of oil, the U.S. and Canada were the only producers in the world that could help cover the supply deficit. As a result, Patterson-UTI has enjoyed a tailwind from increased drilling activity since the onset of the Ukrainian crisis early last year.
The tailwind from the sanctions on Russia and the deep production cuts of OPEC were clearly reflected in the performance of Patterson-UTI last year. After seven consecutive years of material losses, the company posted adjusted earnings per share of $0.71 last year.
Even better, OPEC has maintained an aggressive policy in an effort to support the price of oil. In early October, the cartel announced a reduction in production of 2 million barrels per day. In addition, earlier this month, OPEC and Russia announced a new round of production cuts, which will total approximately 1.6 million barrels per day.
The latest announcement triggered a rally of the price of oil. The move of OPEC is likely to benefit the business of Patterson-UTI, as North American oil producers are the only ones who can help cover the supply deficit caused by the latest round of production cuts of OPEC and Russia. Analysts seem to agree with this view, as they expect Patterson-UTI to grow its earnings per share from $0.71 in 2022 to $1.70 this year.
On the other hand, it is important to note that the business of Patterson-UTI seems to be approaching a plateau. In the fourth quarter, its average rig count rose from 128 in the third quarter to 131 but management expects an average rig count of 130 in the first quarter of this year and a modest increase throughout the rest of 2023.
Threats
As mentioned above, the pandemic severely affected the business of Patterson-UTI. However, it is important to note that the company has made a meaningful profit only once in the last eight years. In other words, the company was facing problems long before the onset of the coronavirus crisis.
The main reason behind the persistent losses of Patterson-UTI was the great technological progress in this business, which enabled oil producers to extract more oil from a fixed number of producing wells. Thanks to technological advances, oil producers are now able to produce more oil with fewer wells than in the past and hence Patterson-UTI generates lower profits at a given level of total production in North America.
Moreover, the rally of the prices of oil and gas to 13-year highs last year caused a global energy crisis, as numerous households struggled to pay for their energy bills. Due to this crisis, most countries accelerated their secular shift from fossil fuels to clean energy sources, in an effort to protect themselves from sky-high prices of oil and gas and improve their environmental footprint at the same time. As a result, there is an all-time high number of renewable energy projects that are being developed right now. When all these projects come online, in 2-4 years, they will almost certainly take their toll on the global oil production. While the impact of these projects on oil production cannot be quantified yet, this secular shift poses a major long-term threat to the business of Patterson-UTI.
Valuation
Although Patterson-UTI is thriving right now, its stock price has declined 15% since my article in October. The divergence between the earnings of the company and its stock price has probably been caused by the aforementioned concerns related to the business of the oilfield services provider, namely a plateau in the short-term business momentum and the long-term threat that results from the accelerated global shift from fossil fuels to clean energy sources.
These threats also help explain the cheap valuation of Patterson-UTI. The stock is currently trading at a forward price-to-earnings ratio of 7.0 . It is also remarkable that the stock is trading at only 5.4 times its expected earnings in 2024. A significant part of the cheap valuation has resulted from the cyclical nature of the business of Patterson-UTI. Cyclical stocks tend to trade at low price-to-earnings ratios near the peak of their cycle.
On the bright side, the cheap valuation of Patterson-UTI probably means that the stock has limited downside in the short run. As long as drilling activity remains healthy in North America, the stock is not likely to decline much further. On the other hand, whenever the oil market faces its next downturn, e.g. due to a recession or the impact of numerous clean energy projects, the stock of Patterson-UTI may decline further.
Upside risk
North American oil producers greatly benefit from the deep production cuts that OPEC and Russia have implemented over the last three years. They reap the benefits from high oil prices without incurring a decrease in their production, in contrast to the members of the cartel. If the output of North American oil producers remains in an uptrend for several years, Patterson-UTI is likely to keep thriving and hence its stock is likely to have significant upside from its current price in such a favorable scenario.
On the other hand, such a favorable scenario has low odds of materializing. OPEC and Russia are unlikely to continue reducing their output indefinitely while the shift of the entire world from fossil fuels to clean energy sources is likely to have an impact on the business of Patterson-UTI at some point in the future.
Final thoughts
Patterson-UTI has greatly benefited from the increased drilling activity in North America, which has resulted from the recovery of the energy market from the pandemic and the deep production cuts of OPEC and Russia. Moreover, Patterson-UTI is likely to benefit from the recently announced production cut of OPEC and Russia. Given also its cheap valuation, the stock seems to have limited downside in the short run.
However, the stock remains risky from a long-term perspective. Its business is facing the threat from a strong secular trend, the shift from fossil fuels to renewable energy sources, which has accelerated due to the recent global energy crisis. The risk of the stock is also reflected in its vast underperformance over the last decade. During this period, the stock has declined 44% whereas the S&P has rallied 160%. Overall, Patterson-UTI seems to have an unfavorable risk-reward profile in the long run.
For further details see:
Patterson-UTI Energy Keeps Thriving But Remains Risky In The Long Run