Weatherford International: Easing Margins Can Mitigate Balance Sheet Risks (NASDAQ:WFRD)
WFRD is on a stable path
Following the recovery in the energy market, Weatherford International (NASDAQ: WFRD) was reinforced by market share gains and price increases. Along with the growth of shale drilling and production in North America, its products and services and contract awards in the Middle East, Latin America, Asia and Sub-Saharan Africa will likely recover in 2022. Along with expanding margins, I believe this will also become positive free cash flow in 2022.
However, supply chain bottlenecks and a tight labor market have limited growth. Moreover, it has high leverage. But, with a solid cash flow, debt management should not be critical in the medium term. The stock is reasonably valued relative to its peers at this level. I think investors want to hold the stock for healthy medium-term return potential.
Weatherford International’s strategic objectives shifted from high-volume, low-margin services to high-margin offerings. I talked about this in more detail in my previous article. While continuing to provide pressure drilling, cementing products, pipe and fishing execution services, it is poised to do more after refining its portfolio, focusing on specialist services.
Demand is growing for WFRD’s integrated MPD (managed pressure drilling) and TRS (tubular operation services). In North America, its outlook was bolstered by market share gains and price increases following higher crude oil prices and increased upstream investment. There has been a significant increase in US drilling activity and associated services. Since the start of the year, the number of active fracking spreads in the United States has increased by 19%, according to estimates from Primary Vision. From December 2021 to March 2022, the number of wells drilled and completed was higher (increase of 17% and 4%, respectively), while wells drilled but not completed (or DUC) decreased by 9%. Many shales saw larger additions to rig counts during this period, which will help boost WFRD’s bottom line.
Growth in international operations
Over the next several quarters, we will likely see the Middle East and Latin America leading the growth in energy activity in WFRD’s operations. Latin America, in particular, will become a priority for the company as it experiences structural changes. In the first quarter of 2022, revenue in this geography grew 29% year-over-year. Asia and Sub-Saharan Africa may see increased demand and higher contract awards. Both of these markets are expected to experience a strong recovery following the ebb from the drop in COVID demand.
Q2 2022 estimates: revenue and margin
In Q2 2022, management expects revenue to grow in the mid to high single digits compared to Q1 2022. Adjusted EBITDA margins may improve by 50 basis points from the Q1 level (16% ). In terms of segment, WCC (Well Construction and Completions) and P&I (Production and Intervention) can generate high single digit growth, followed by D&E or Drilling & Evaluation (mid single digit growth).
Although the conflict between Ukraine and Russia may have negative effects, the company estimates that only 1% of its revenue is generated in Ukraine. In addition, strong demand growth in other international regions following higher crude oil prices and increased capital investment, driven by an increased focus on energy security and supply, are expected to boost WFRD revenue in the second quarter. Positive factors can also lead to positive free cash flow in 2022.
Analysis of first quarter financial results
In the first quarter of 2022, increased demand for cementing and activity products in North America allowed WCC segment revenues to remain stable compared to the fourth quarter of 2021. On the other hand, the increase in logistics costs and the challenges in the supply chain had a negative impact on the timing of product delivery in North America. This caused Production & Intervention revenue to decline 4% quarter-over-quarter in the first quarter. Adjusted EBITDA margin improved 100 bps sequentially in Q1 2022.
One of the main performers of WFRD has been Managed Pressure Drilling, or MPD. Recently, it has formed a collaboration in Rotary Control Devices and Annual Isolation Device in its Underwater Services. It will integrate MPD into a single automated connection for all drilling operations and help increase production while reducing well construction costs. The integrated service was deployed on the ultra-deep drill ship Maersk Viking.
The current financial situation
As of March 31, 2022, WFRD had $2.4 billion in debt, while its cash and cash equivalents were $841 million. Despite higher revenues, its operating cash flow turned negative in the first quarter of 2022 compared to a year ago. The energy up-cycle increased its working capital requirement in the first quarter. Additionally, capex increased, leading to a significant drop in free cash flow (-$84 million) from positive FCF a year ago. The company’s debt (or leverage) ratio of 5.7x remained higher than that of its peers (BKR, NOV, NBR) due to its high debt level and low equity base.
What does relative valuation involve?
Weatherford trades at an adjusted EV/EBITDA multiple of 6.9x. Its contraction in the EV to EBITDA multiple is less pronounced than the average of its peers, as sell-side analysts expect its EBITDA to grow less sharply than its peers over the next four quarters. This usually results in a lower EV/EBITDA multiple. The stock’s EV/EBITDA multiple is lower than the average of its peers (BKR, NOV and NBR) of 16.3x. Thus, the stock is reasonably valued at the current level.
Analyst rating and target price
Two sell-side analysts called WFRD a “buy” in March, while none of the analysts called it a “hold.” The consensus target price is $51.3, which gives returns of around 53% at the current price.
According to Seeking Alpha’s quantitative rating, the stock has a “hold” rating. While ratings are moderate on momentum and valuation, they are mediocre on growth, profitability and revisions.
What is the view on WFRD?
Over the past year, Weatherford has benefited enormously from the rapid recovery of the energy sector and its strategic repositioning. Despite some slowdown in the Well Construction & Completion and Production & Intervention segments, the company’s focus on margin expansion paid off. Demand for its integrated MPD and TRS services is growing in the United States. Internationally, the Middle East and Latin America will lead the charge in 2022. Thanks to this positive momentum, the stock has outperformed the VanEck Vectors Oil Services (OIH) ETF over the past year.
Given the relative valuation, you could hold the stock for a relatively long period for a steady return. However, some shortcomings are also visible. Its debt ratio is too high compared to its peers in the sector. Negative cash flow in the first quarter means that deleveraging initiatives won’t be easy. Nevertheless, the company has a strong cash balance, which reduces the risks associated with a highly leveraged balance sheet and encourages investors to hold onto the shares.