Description

Company: Patterson-UTI Energy, Inc.

Ticker: PTEN

Investment: Equity Short

Timeline: One Year

Current Price: $19.06

Target Price: $12.00

Business Description: PTEN own and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment.

Investment Overview Thesis: PTEN’s stock is up 50% in the past three months, due to the increase in oil prices, not due to a significant change in the company’s underlying business. The key driver for PTEN – rig utilization - continues to decline.

While leverage is manageable today at 2.4x (run rate EBITDA, less early termination fees), if the investment thesis holds, leverage will increase to 4.1x by year our 2016 EST, creating the stock at 17.2x 2016 EBITDA, compared to 9.9x EV/EBITDA (run rate EBITDA, less early termination fees). Applying a 10x multiple on our $207MM EBITDA 2016 results,  implies a stock price of $9.00 (PTEN traded at 10x in Q4’09 – the previous cycle’s bottom), we use a 12x multiple for our stock target - resulting in a target of $12, as PTEN’s fleet is of high quality compared to its previous downtown.  

Company Segments

1) Contract Drilling

A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. A drilling rig is marketable at a point in time if it is operating or can be made ready to operate without significant capital expenditures.

At December 31, 2015, PTEN had a drilling fleet that consisted of 221 marketable land-based drilling rigs. Of which, 80 drilling rigs were operating in the United States, a decrease of 63% from the recent peak of 214 rigs in October 2014. PTEN’s operating rig count has continued to decline in 2016, with on average, 78 operated rigs in the United States during January 2016.  PTEN also has a substantial inventory of drill pipe and drilling rig components that support drilling operations.

46 in west Texas and southeastern New Mexico,

17 in north central and east Texas and northern Louisiana

36 in the Rocky Mountain region (Colorado, Wyoming and North Dakota),

37 in south Texas,

29 in western Oklahoma,

45 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and

11 in western Canada.

PTEN talks extensively about its APEX rigs, which make up ~73% of its 221 rig fleet, or  161 APEX rigs (as of the 3/8/16 Raymond James call, though from the below HP presentation – HP claims they are not all AC drive rigs). The company started building these in 2006 (its averaged ~20 rigs a year from ~2009-~2014).As not all APEX rigs are equal, this particular part of the rig fleet divides as follows: 128 are 1,500 horsepower, 30 are 1,000 horsepower, and a few are 2,000 horsepower.  The APEX rigs drive the majority of PTEN’s EBITDA and as of early March all of PTEN’s active rigs were APEX rigs and one mechanical rig (non-APEX). The APEX rig is a called ‘a walking rig’ because the rig's walking system allows it to move across the drilling location while crews continue to work around the unit. The drill pipe is carried in the derrick when the rig is walked - because drill pipe does not need to be laid down, additional time is saved. The company’s APEX-XK 1500 is it’s best with the latest in AC drilling technology and can move from wellhead to wellhead in about 45 minutes, and be back to drilling in three hours

For years PTEN was viewed as having older, less high tech rigs versus its peer Helmerich & Payne, PTEN’s focus on APEX rigs was a bid to catch up to its rival. The problem is, PTEN wasn’t the only one who pushed into new high tech rigs to get a head in the industry. Everyone in the industry leading into the oil correction built its own high tech rigs, whether there were called a FlexRig (Helmerich & Payne), ShaleDriller (Independence Contract Drilling), APEX (Patterson-UTI), PACE-X (Nabors Industries Ltd.), Super Triple (Precision Drilling), ADR (Ensign Energy Services), BOSS (Unit Corp.) or other Tier 1 shale rig, the industry witnessed a large build up in new high spec land rigs to gain on performance and cut costs.

Just how many ‘high spec’ rigs were built in the US? Unfortunately there is no rig SAAR, however….

“At the end of 2009, there were only about 275 AC rigs, accounting for 37% of horizontal and directional activity….The industry has added consistently 50 to 150 AC rigs per year, totaling about 800 rigs by the fourth-quarter 2014 peak and accounting for 50% of total horizontal and directional activity. Since the 4Q 2014, AC rigs have fallen at a slower pace than less capable rigs and now account for about 67% of horizontal and directional activity.” E&P Magazine, 6/1/15

With the 4/22/16 US Land Rig Count at 401, and ~800+ of AC rigs in the market, there are today too many AC drive rigs in the market…

“The tone in 2016 has shifted to lower for longer. The industry has idled over 1,400 rigs in the U.S. since the peak rig count in October of 2014, and it continues to decline. Of those 1,400 rigs that have been idled, approximately 900 are legacy SCR and mechanical rigs, and approximately 500 are AC drive rigs. The industry is experiencing dramatic reductions in personnel and investments, and clearly, a number of companies are struggling to survive.” HP 1/28/16 Q1’16 Earnings Call

The high tech rig prices are not immune to the downturn….

“Average FlexRig spot pricing is down by more than 35%, as compared to spot pricing at the peak in November 2014, and it may continue to decline.” Helmerich & Payne Scotia Howard Weill 44th Annual Energy Conference March 22-23 2016

However, rates may have approached a bottom….

“Excluding the impact of revenues corresponding to early terminated long term contracts, we expect our average rig revenue per day to be roughly flat….” HP 1/28/16 Q1’16 Earnings Call

Too bad utilization hasn’t….”Looking ahead to the second quarter of fiscal 2016, we expect revenue days to decrease by close to 20% quarter-to-quarter.” HP 1/28/16 Q1’16 Earnings Call

PTEN gives us a good idea of how utilization has declined in the past few months.

In 2015, the company benefited from term contracts, PTEN expects an average of 59 rigs operating under term contracts during Q1’16 and an average of 46 rigs operating under term contracts during 2016.

2) Pressure Pumping Services

Services to oil and natural gas operators primarily in Texas and the Appalachian region.  Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2015, PTEN had approximately 1.1 million hydraulic horsepower to provide these services. Pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite.

PTEN’s pressure pumping business experiencing the effects of reduced spending, pricing and usage has declined. At December 31, 2015, PTEN stacked 38% of its fracturing horsepower.  The company has seen a significant decrease in available work, and the profitability of available work has continued to deteriorate.

Since the beginning of 2016, PTEN stacked ~140,000 fracturing horsepower and now has stacked slightly more than half of its fleet of more than 1 million hydraulic fracturing horsepower.

3) Other / oil and natural gas assets

PTEN owns and invests in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in Texas and New Mexico.

Industry Overview

Initially I was drawn to NBR as a short instead of PTEN as it is far more levered, lower short interest and trades ~1x wider on an 2015 EBITDA basis (not shown above)…However, as shown above, that isn’t the case on 2016  expectations. NBR has several things going for it that PTEN does not, NBR has 1) ~50% of sales / ~55% of EBITDA was generated outside North America in 2015  with half of NBR’s rigs in the middle east. The international market has been an area of strength for the industry during the downturn.  NBR’s international rig fleet is one of the largest in the industry and in the past has been rumored to be a potential target for a buyer in the past. The valuation difference between PTEN’s 2016 expected EBITDA and peers, high YTD stock performance and increasing leverage is the crux of the short story.

Valuation

PTEN’s model is driven by two major factors – APEX rig utilization and APEX rig rates. The company has previously mentioned that 59 rigs would be under contact in 1Q, on 4/5/16 the company released that their Q1’16 rig count was 71 (down 19% q/q) with 64 for March. Using contracted rigs as the majority of APEX rigs in service w/ added in color given on 4/5/16 to gross up total rigs and keeping flat day rates and a small (2%) increase y/y in daily cash costs (this figure likely understates the additional rig staking cost) takes EBITDA for the drilling segment to $195MM for 2016, compared to a (not incl corporate cost) 2015 mgt segment EBITDA of $527MM ($456MM ex-early termination fees) or a run rate of $383MM ($346MM). Keeping the other segments flat from Q4’15, including corporate cost, results in a consolidated 2016 EBITDA of $207MM.  

Risk

Investors may be look beyond 2016 to 2017 results and assume that 2017 will have a rebound in land rig drilling. Consider a pair trade, short PTEN / long HP if this occurs as HP has a better fleet and better balance sheet. HP also screens cheaper on 2016 consensus EBITDA and rallied less than PTEN YTD.

Rig utilization upside? A main risk is if 2017 sees a drastic run up in rig utilization, however if 2016 is the bottom, PTEN’s stock has overshot this and is currently trading above its previously historic low.

Catalyst

2016 results