The market could be ready to make a sharp turn higher in the valuations of the smaller oilfield service-OFS companies. Since May of this year the bigger players with multi-national footprints such as Halliburton, (NYSE:HAL), and Schlumberger, (NYSE: SLB) have rallied relentlessly. HAL is up 66% and SLB has risen 50% from May lows. Smaller companies like ProFrac Holdings, (NYSE:ACDC), and Select Energy Services, (NYSE: WTTR) have traded flatly or trended down- out of sync with oil prices, which have rallied 45% from May lows in the 70’s.
The catalyst for these smaller companies has arrived along with the end of the decline in the Rig Count. According to Baker Hughes, a net 9 rigs went back to work last week as producers shifted their bets to oil prices remaining above $80 per barrel.
In this article we will look at one company in particular to see what this reversal of fortune might mean. ProFrac Holdings has been hit particularly hard with its stock price declining from $24.68 in January to a low of $9.44 in May. Recent trading has seen some price improvement toward the $12.00 level, but there could be much more to come.
The turn in the market
Beginning in early July, a strong price signal was sent to the oil market, that new drilling was needed, and rigs should be going to go back to work. There is a reasonable delay, usually, 2–3 months between strong price signals and a response from the Opco’s to initiate new drilling. As of September, 15th 9 rigs went back to work, suggesting that the price signal was enough for them to take action.
The chart above shows the lag between moves in WTI and rig activity. On the first of September, the price of WTI hit $83.63 and arrested the decline in the rig count. Rigs held flat at 631-2 through the 8th, and on the 15th, 9 rigs went back to work, as noted.
How many rigs are going back to work? My sources tell me we aren't likely to see the 755 that we closed out March with, again soon-we don't need them to maintain output, but we might see 700. Let's work with that figure.
The math looks something like this. Last year, with about an average of ~700 rigs running, we drilled 786 wells per month. Now, with 632 rigs running, we are drilling at a rate of ~720 wells per month as of August (Data from Ted Cross of Novi Labs). Logic would then suggest that we move back toward that 700 rigs figure, or pick up about 68 rigs over the course of the rest of 2023.
Finally, the ratio of frac spreads to rigs also gives us a clue as to how many pumping spreads could go back to work. March 1st, when we had 755 rigs turning to the right, there were 2.55 rigs for each frac spread. Now, with 632 rigs, we are at 2.50 rigs to spreads, so there's a reasonable relationship established. With 252 frac spreads in the field, (Data from PrimaryVision), we should also see about 30 frac spreads going back to work to maintain that rough ratio.
Over the last couple of years the company has made a number of key acquisitions to build market share. Starting with Rev Energy Services and Producers Services, and then continuing to U.S Well Services , ProFrac absorbed these smaller frackers into its network. In each case, they brought additional market share, and in the case of U.S. Well Services, new technology in the form of “E-fleet,” electric frac technology. It's also bought a bunch of little to medium-sized sand companies this year; Performance Proppants, SP Silica of Monahans, Monarch Silica and Signal Peak of Monahans, were all snapped up in the space of a year or so. This consolidated the market and improved logistics for ProFrac in key plays such as the Delaware basin, the Haynesville, and the Eagle Ford.
This market consolidation also has the advantage of encouraging operators to bundle sand and pumping, something they got away from a few years back. Sand contribution margins have improved dramatically at 5-year highs at $28-30.00 per ton, making this a good move for ProFrac.
It is estimated that ProFrac has about 12% of the North American pumping market. This corresponds fairly well to an analyst’s estimate of 35 active fleets in Q2. If you take my quick and dirty average of 274 active fleets for the quarter, that figure gives you 12.7%, so we are in the ballpark. The market has deteriorated to an average of 258 active fleets so far in Q3, so using that 12.7% as a guideline, ACDC's share has fallen to about 33 fleets or a drop of two in Q3.
As rigs ramp up in response to higher oil prices, frac spreads will follow to maintain that rough 2.5:1 ratio. If we do indeed see another 30 spreads reactivated, with 12% of the market, it could mean another 5-6 spreads coming back to work for ProFrac.
Risks to this thesis are primarily the fragility of the oil price ramp since early July. This has been driven by a massive decline in U.S. and global storage, as noted by Eric Nuttall of Nine Point Partners, noting in a recent Twitter posting that U.S. inventories will exit 2023 at ~378 mm barrels, and global inventories at ~750 mm barrels. This has enabled the oil market to look past worries-China recovery, and the U.S. Fed funds rate increases primarily, which have kept a lid on oil prices over the summer. We think that period is in the rearview mirror for the time being, but any significant inventory builds would put the brakes on the oil price rally.
As I’ve noted above, the wave that has carried the bigger companies with international exposure higher has missed some of the smaller North American-centric OFS companies. We think better times are ahead for these companies, and the easiest path forward for their shares companies is higher, in particular, the shares of independent fraccing companies like ProFrac Holdings.
In the case of ProFrac, the Analyst’s price targets range from $12 on the low side to $18.00 on the high side, with a median of $15.00. They also have the EPS forecast for Q3 to be $0.15 per share, an increase of $0.17 from the -$0.02 per share recorded for Q-2. The current EV/EBITDA of ACDC is 3.85X or a Next Twelve Month-NTM basis.
If they hit that $0.15, EBITDA would move back toward a NTM of $932 mm, or an EV multiple of 2.85X. To keep that multiple the same at 3.85X, the shares need to rerate toward $15.50, giving the stock a 26% upside from current prices. If they were to beat it, the stock might regain previous highs in the mid-$25's on improved fundamentals.
Given all of those trends in the market, I think ProFrac Holdings Corp. presents an attractive entry point at current prices. Investors with a reasonable risk tolerance may wish to look closely to determine if a company like ProFrac rates a place in their portfolios for growth.
By David Messler for Oilprice.com