Description

Investment Thesis- Short Precision drilling due to the poor outlook on E&P spending and rig rates coming down in the near term. The reduction in E&P capex and additional drilling efficiencies will lead to a 100-150 rig count reduction and/or significantly lower day rates to offset the incremental rig cost. PDS also has the most exposure to Canada and the least exposure to high performance rigs.

E&P Debt Is Unsustainable- current strip will cause greater outspend in 2016

·         Currently outspending by >30% of cash flow in 2016 vs only 20% in 2015

·         Debt to Trailing EBITDA is 2.7x today but will be north of 4x by YE 2016 at current spend rate using strip

E&P Summer ’15 Theme- stay CF neutral in 2016.

·         Projected outspend is estimated at north of $13bln.

·         Assuming $3/mcf and 35% of WTI, the average breakeven wellhead price for oil is ~$40/bbl. Oil strip is approaching capital weighted corporate level breakeven pricing. With low commodity pricing and the inability to hedge due to the current strip doesn’t warrant further industry investment.

 

 

 

 FED & Lender Demands

·         The FED has mandated that the lenders reserve more cash against the reserve base lending (RBL) facilities.

·         Banks are being forced by the FED to be stricter on their lending practices in which they created a “substandard group” for E&P and service companies.

o   Covenants of 4x & 5x debt to trailing EBITDA put you into two different categories.

·         Debt to trailing EBITDA will approach substandard levels for most E&Ps under current commodity strip assuming current sell side capex guidance

·         If an E&P company is labeled substandard, lenders are strongly suggesting asset sells to raise equity before the spring redetermination

·         New Lending Commodity Decks

o   Base case =’s $43 & $2.70

o   Downside Case of $32 & $2.25

·         Even healthy E&P companies are virtually being forced to slow down or run the risk of being put in the group sometime in 2016 

Service Company Issues

·         Sell side expectations are estimating that 200-300 rigs will be added in 2016.  That won’t happen unless the commodity sits above $60 for a meaningful period of time to allow for E&P companies to layer in hedges.

·         Service companies were bullish on the recent rig count jump due to their clients ability to hedge for a two month window with WTI >$60/bbl. Many energy companies such as EOG used this opportunity to hedge the commodity and postpone their drilling and completing commitments until until their newly hedges were in effect.

·         E&P companies are alluding to another ~10% efficiency gains from drilling faster from understanding the geology, pad drilling and better rigs. E&P’s also believe what isn’t being captured by the sell side is that the remaining crews are working longer and harder than normal for free in hopes that they’ll keep their job.

·         E&P companies are telling their service providers that they need additional price concessions of 5%-15% or they’re going to be forced to lay down additional rigs.

·         Assuming 30% cash flow outspend plus 10% efficiency gains, the rig count could reduce by 100-150 rigs from today’s levels. 

AC Estimated Rig Count by Company

·         75% of the market is controlled by HP, NBR, PTEN, PDS

·         PDS has the least amount of exposure to the preferred rigs defined as 1500 hp, AC drives, 750klb hook load, pad capable. 

 

 

 

PDS has the highest debt to capitalization ratio out of their peers . In other words, they pay more interest expense per preferred rig than their peers. ie higher operating cost

 

Legacy rig contracts are rolling off forcing spot pricing lower or incremental stacking due to the lack of opportunities

·         Non-preferred rigs won’t find a job in the spot market today

Valuation/Cap Structure

Assuming a 7x EV/EBITDA for 2016, the stock is worth $3.25/sh or 37% down from here. 

Channel Checks

·         Private rig operators and a half a dozen E&P companies: AC rig spot rates for preferred rigs (1500hp, walking, Gen3) think that $15k/day even in the Permian will be the new rate in short order. Street is modeling $18k-$21k spot rates. Operating costs are approximately $13.5k/day for the industry on the preferred rigs.

·         Rig operators- AC rigs are trading at ~ 50 cents on the dollar in secondary mkt. Mostly parts suppliers buying equipment. Holds true for AC rigs 3-5 years old. 

Risks

Recent technical bounce keeps the heavily shorted names underperforming. Fundamentals such as large crude injections into the oversaturated crude market doesn't matter.

Dumb investors keep bailing out the E&P companies via equity deals to drill uneconomic wells

WTI bounces back to high 50’s low 60’s to provide hedging opportunities. This gives the E&Ps the opportunities to also lock in rig contracts a low rates. 

China demand picks up faster than anticipated

Iran brings on less than 300kbblspd

Consolidation within the services space bids up the survivors

Catalyst

E&P companies cut capex budgets by 25% at ye to protect balance sheet

PDS stacks a disproportionate amount of rigs because their rigs are less desirable

Rig rates cut significantly close to operating margins.