PRECISION DRILLING CORP PD.
March 01, 2021 - 2:58pm EST by
TRUTH_SEEKER
2021 2022
Price: 29.40 EPS N/A N/A
Shares Out. (in M): 14 P/E N/A N/A
Market Cap (in $M): 396 P/FCF 4.2 3.1
Net Debt (in $M): 1 EBIT -82 -16
TEV ($): 1 TEV/EBIT N/A N/A

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Description

Precision Drilling Corporation (“PDS” or the “Company”) provides onshore drilling as well as completion and production services for exploration and production companies in the oil and natural gas industry.

I recommend purchasing PDS’s stock (which is dual-listed in Canada and the United States).  Yes, PDS is in the oil field services sector, which has been a black hole for investor capital.  And yes, it has rallied considerably from its March 2020 lows and is up approximately 40% year to date.  But in my view, PDS is not a POS and to the contrary, should have substantial room to run amid what I believe will be continued improvement in the Canadian and U.S. land drilling market. 

Notably, the Company generated free cash flow during 2020 as it has for most of the past decade.  Moreover, over the next two years, I project that it will generate free cash flow in excess of 50% of its current market capitalization as it substantially de-leverages and de-risks its balance sheet.  Free cash flow aside, the Company has a market-leading position in Canada and a top-four position in the United States, with a fleet in which it has invested a substantial amount of capital over the past decade.  Moreover, with substantial liquidity, a manageable maturity stack and a highly variable cost structure, the Company faces little insolvency risk today or even in an environment where commodity prices weaken.

Capital Structure

Below is PDS’s capital structure.  Consistent with a debt reduction goal of C$800 million between 2018 and 2022, the Company is poised to pay down approximately C$250 million of debt over the next two years.  Over the medium term, it aims to reduce net leverage to below 2.0x, which I think is achievable by 2024.  While the Company has debt maturities before then, it should have little difficulty refinancing its 2023 unsecured notes or extending its revolver.  In addition, although PDS is subject to maintenance covenants under its revolver and real estate credit facility, covenant compliance is unlikely to be an issue (and if necessary, the Company should be able to secure amendments).

Business Overview

PDS operates across two segments: (i) Contract Drilling Services and (ii) Completion and Production Services.  Because Contract Drilling Services is by far the more significant of the Company’s businesses—accounting for almost all of its revenue and pre-corporate EBITDA in 2020 and prior years—the discussion below focuses on this segment.

In Contract Drilling Services, the Company provides land drilling services in Canada, the United States and select international markets as well as directional drilling services in Canada and the United States.  The Company operates its land drilling fleet pursuant to contracts with oil and gas producers, which in Canada and the United States tend to run 6 to 18 months at either fixed day rates or to a lesser extent, performance-based rates.  If a rig under contract is not working, the Company will generally receive compensation that is slightly greater than what would have been its gross margin.  Because almost all of the Company’s cash costs are operating expenses related to drilling, the Company has a highly variable cost structure that scales down during low activity periods.  Owing to this variability as well as the Company’s relatively low maintenance capex per rig, PDS was able to generate cash in 2020 notwithstanding a substantial decline in utilization.

Canada (105 Rigs, ~30% of FY 2020 Contract Drilling Revenue ex. Directional Drilling)

PDS has a leading position in the Canadian land drilling market, with over 30% market share.  Even before the emergence of COVID-19, the Canadian market was challenged owing to structural problems with takeaway capacity.  These problems have improved somewhat, and on a seasonally-adjusted basis, demand is picking up from the 2020 lows.  In the latter regard, the Company noted on its Q4 2020 earnings call that Q2 2021 demand looks to be almost double Q2 2020.  Furthermore, although the aggregate level of utilization for the Company’s Canadian rigs has been low (~27% in 2020), pockets of the market have been, and are expected to continue to be, strong.  Specifically, in liquids-rich Canadian basins such as the Montney and Duvernay that require deeper rigs, utilization during the winter season has recently approached 80% and pricing remains firm.  In addition, substantial capacity has been taken out of the Canadian market, with PDS alone cutting Canadian rig count by nearly 40% since 2014.

United States (109 Rigs, ~60% of FY 2020 Contract Drilling Revenue ex. Directional Drilling)

PDS is a top-four player in the U.S. land drilling market, behind Helmerich & Payne, Inc., Nabors Industries Ltd. and Patterson-UTI Energy, Inc. and slightly ahead of Canadian peer Ensign Energy Services Inc.  Unlike other sub-sectors of oil field services, U.S. land drilling is relatively concentrated, with the top four companies (including PDS) accounting for approximately 80% of the “super-spec” rigs available in the lower 48 United States.  These more technologically advanced rigs (compared to “legacy” rigs) account for most of the rig utilization in the United States and an even higher share of revenue given their higher pricing relative to legacy rigs.  Owing to substantial capex over the past decade, about 65% of PDS’s U.S. fleet now falls into the super-spec category, with another 10% to 15% capable of upgrade at fairly low cost (between $6 million to $10 million per rig).

Looking forward, I think that PDS’s U.S. land drilling business should pick up materially as utilization in the lower 48 continues to climb from the 2020 trough.  Pricing may be a moderate headwind as pre-COVID contracts roll off into new contracts at lower spot rates, but PDS believes that pricing has bottomed and that renewal rates have been sticky.  It is difficult to say how high utilization might go given the focus on capital discipline among producers, particularly large, public companies.  However, since PDS was operating in the United States at approximately 70% utilization in 2018 and 2019 and ended 2020 at under 25% utilization, there is substantial upside from here.

International (13 Rigs, ~10% of FY 2020 Contract Drilling Revenue ex. Directional Drilling)

In addition to U.S. and Canadian land drilling operations, PDS has a small international land drilling business focused on the Middle East.  Given its size, I do not view this business as core to the Company’s current value proposition though it has been more stable than the Company’s U.S. and Canadian operations.

Valuation

Below is a simple operating model illustrating the potentially substantial cash flow that PDS might generate over the next four years.  Notably, while I do assume a continued strengthening of the land drilling market, I do not assume that utilization surpasses PDS’s five-year average prior to COVID until 2024.

Based on the numbers above, I believe that PDS equity could be a multi-bagger from current levels over the medium term.  The chart below illustratively shows the annualized return as a function of free cash flow yields based on 2023E levered free cash flow.  While I am not smart enough to pinpoint the precise free cash flow yield or free cash flow for PDS in three years, I think it is clear that the Company’s equity has substantial torque.

Risk

The largest risk to the thesis above is a sustained downturn in commodity prices comparable to what we saw in 2020.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

There is no specific catalyst here, but I believe that the stock should continue to trade up as rig count increases and financial results improve.

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