The oil market is like a roller coaster, full of ups and downs. During booms, companies make big profits, but downturns can be tough. In this cyclical industry, success often depends on building a resilient business capable of weathering stormy cycles. Helmerich & Payne (NYSE:HP) is a classic example of such consistency. Despite short-term challenges that could hurt its earnings, the company appears to be moving in the right direction.
I last discussed Helmerich & Payne over two years before, when he was navigating a loss, but showed promise for a comeback – a turnaround that he successfully achieved. Today, the company finds itself in a tough spot again, dealing with reduced drilling activity. However, amid the current market turbulence, Helmerich & Payne has some good things going for it: strategic moves that not only promise to keep the company profitable, but also strengthen its ability to handle the future industry cycles.
Helmerich & Payne, or H&P, the century-old, reputable provider of oilfield services, is navigating a particularly tough market. Known for its high-performance drilling rigs and offshore platforms, the company boasts a substantial fleet, primarily active in the US, of over 250 drilling rigs and seven offshore platforms.
However, even a company as established as H&P is not immune to market fluctuations. The U.S. oilfield services sector faces a sharp decline in 2023. Oil and gas producers have scaled back, removing rigs in response to fluctuating commodity prices. Currently, WTI crude oil prices hover around $78, reflecting levels seen earlier in the year, but with significant volatility throughout the year. Henry Hub natural gas prices, on the other hand, have fallen over 20% over the same time frame. This market scenario has led to a sharp decline in the number of devices in the US, falling from 772 at the beginning of the year to 616 recently, as reported by Baker Hughes (BKR). I have discussed this in detail in my previous article.
This downturn has inevitably affected demand for H&P’s services, particularly from its core customer base of oil shale producers in the U.S. Even with these difficult conditions, I think H&P has done an impressive job of protecting its pipeline. its final. H&P finished the quarter ending in September 2023 with 147 active rigs, down from 176 rigs a year earlier.
In response to reduced demand, H&P strategically refrained from lowering its prices to maintain market share. That decision paid off for its North American Solutions segment, which continued to generate substantial revenue of $37,300 per day, up from $29,500 per day a year ago, and achieved impressive direct margins of $17,500 per day , an increase from $12,600 per day at the same time. the period of the previous year. This focus on margin protection was a significant contributor to the company’s adjusted earnings of $0.69 per share for the quarter, up from $0.45 per share in 2022.
Despite H&P’s resilience, the continued decline in drilling activity casts a shadow over the industry. The business environment remains tepid with WTI oil prices retreating below $80 a barrel at the time of this writing from a September high of over $90, even with OPEC+ production cuts. Predictions from IMF AND World Bank suggest a global economic slowdown next year, potentially reducing oil demand. US oil producers, already cautious with their spending, are likely to maintain this prudence. Their main focus will likely remain on keeping CapEx low, optimizing free cash flows and rewarding shareholders through dividends and buybacks.
Another concern for H&P and other rig providers is the paradox of rising US oil and gas production amid rig removal. U.S. crude oil production rose by 12.56 million barrels per day [bpd] in January to 13.05 million bpd in August, with dry natural gas production also rising from 3.16 trillion cubic feet to 3.23 trillion cubic feet over the same period, according to data from the US Energy Administration.
This trend can be attributed, among other factors, to increased efficiency among oil and gas producers, who are now able to extract more with less equipment. This may have been driven by advances in technology and the significant increase in drilling intensity over the past decade. For example, H&P’s FlexRigs are now drilling 4.5 times more wells per year compared to a decade ago. However, this increased efficiency comes at a cost, notably increased maintenance costs for service providers. Additionally, ongoing mergers and acquisitions in the upstream sector, exemplified by Exxon Mobil’s (XOM) Pioneer Natural Resources acquisition (PXD), can further simplify operations. These consolidations may result in manufacturers requiring even less equipment to support or increase their production.
Efficiency gains in oil production do not bode well for future drilling activity. Unless there is an unforeseen increase in oil prices, the rig count may continue its downward trajectory. H&P has he expressed honestly that while demand for its high-performance equipment may increase in 2024, overall activity levels are likely to remain below last year’s peaks. Therefore, I believe the number of active rigs under H&P’s operation may remain low. This sustained decline in drilling activity could ultimately impact H&P’s financial performance, potentially leading to year-over-year earnings declines.
Two bright spots
However, there are two main areas where H&P investors can find optimism. First, the company’s approach to maintaining its margins in this cycle is worth noting.
Unlike previous downturns, where H&P cut prices to maintain market share at the cost of its profits, the current strategy emphasizes “increased focus on the contract economy” over market share. This change is essential, especially now, as oilfield service companies face inflationary pressures. Rising operational costs, including labor costs and the need for more intensive platform maintenance, make it unsustainable for H&P to cut prices just to maintain market share. In this high-cost environment, preserving margins appears to be the prudent approach, and I expect this strategy to support H&P in maintaining stable returns, even with continued weak drilling activity.
Second, I believe that H&P’s potential for international market expansion presents a long-term growth opportunity. Although H&P has operated in international markets for several years, particularly in Argentina and Colombia, the size and scale of its international business has been modest compared to its North American operations. The company averaged just 13 active platforms in international markets last quarter, compared to 149 in North America. But this can fundamentally change.
For example, H&P’s recent establishment of an office in the Middle East, perhaps one of the most important oil and gas markets in the world, signals a strategic move to expand operations, improve customer service and increase competition. . The company has already secured work with Saudi Aramco, planning to deploy a super-spec rig in the coming months, with operations expected to begin in the second half of 2024. Additionally, H&P is exploring opportunities in regions such as Australia, where he has already placed a super-specific device.
The significant investment underscores H&P’s commitment to international growth. Of the $450 million to $500 million budgeted for gross capital expenditures in FY-2024, about one-third is allocated to international ventures.
However, it’s important to recognize that international expansion is a gradual process, involving building customer relationships, navigating lengthy bidding processes and deploying equipment – a timeline that can take much longer than 12 months. The tangible impacts of these efforts are likely to become more visible from FY-2025 onwards.
In my view, successful international expansion could be transformative for H&P. Industry giants such as Schlumberger (SLB) and Halliburton (HAL) have more effectively weathered oil price cycles in part because of their extensive global presence. Unlike the US, where drilling activity has declined, the international market remains more stable, providing a strategic advantage for companies with a global footprint. As H&P expands internationally, it will not only gain access to new business opportunities, but also potentially mitigate the effects of domestic market fluctuations. I think this move could be particularly beneficial as international oil companies explore more and more unconventional resources. H&P’s ability to move equipment into high-demand markets could offset any downturn in the US sector, positioning the company for a more balanced and resilient future.
H&P finds itself navigating difficult times, and I expect the continued weakness in drilling activity to weigh heavily on the company. The challenging business climate poses a risk to its revenue growth. On the bright side, H&P’s strategic emphasis on maintaining margins is commendable. This focus is vital for the company to maintain profitability and continue to generate good earnings amid market weakness.
Additionally, H&P’s expansion into international markets, while unlikely to bring immediate revenue benefits, sets the stage for long-term growth and a stronger market position. This move could act as a buffer against market volatility and could eventually become a key driver of earnings growth, possibly from 2025.
However, H&P’s stock performance reflects the difficult environment in which it operates. Shares have fallen nearly 10% over the past month and are currently trading at a forward earnings multiple of 11.05x, slightly above the sector average of 9.8x, based on Searching Alpha data. This positions the stock with a Evaluation grade of “C” according to Alpha Quant Factor Grade Research. From my perspective, H&P stock does not present an attractive valuation at present, especially with the near-term outlook for weakened earnings.
Given these considerations, I would advise investors to exercise caution at this time. It may be wise to stand aside for now, monitoring H&P’s progress and waiting for a more convenient entry point.