Earnings Report Q4 2016

At the close of each quarter, I joyfully (or sometimes not so joyfully) read through the major OEMs earnings conference calls in hopes of finding gyms. I don’t really focus on how much money a company made or lost, I look rather to see if I can discern the Company’s attitude towards the market and its future. This week, we will feature several companies, with more companies to follow in the next edition of the Standard. As usual, I have tried to bold the most important points so you can skim the rest.

Schlumberger

On January 20, 2017, Schlumberger’s executives released their Q4 216 results during a conference call. Schlumberger announced earnings per share, excluding charges and credits, of $0.27, which represents an increase of $0.02 sequentially and a decrease of $0.38 compared to the same quarter last year. Q4 revenue was %7.1 billion, an increase of 1% sequentially.

Revenue of its various business groups were as follows:

• Drilling group revenue of $2 billion was sequentially flat, although margin increased 81 basis points to 11.6%
• Production group revenue of 2.12 billion increased 5%, while margin increased 134 basis points to 6%
• Cameron Group revenue of1.3 billion was essentially flat. Margin decreased 207 basis points due to a drop in drilling projects.

Other significant highlights from the conference call:

• Cameron group had EBIT margins at 14% (200 basis points lower than Q3) due to reduced volume
• OneSubsea had excellent margins of 20%. One Subsea was awarded several major projects, including their first subsea tree for Statoil.

CEO Paal Kibsgaard Made the following points, which I will largely quote:

• Our revenue in the fourth quarter of 2016 increased 1% sequentially to reach $7.1 billion as growth in North America land and robust activity in the Middle East largely offset continued weakness in Latin America and seasonal declines in other parts of the world.
• In North America, overall revenue increased 4% sequentially driven by an improving land business in the US and Western Canada as drilling and completions activity increased and service pricing started to recover.
• Offshore revenue declined again sequentially as the recon dropped further and pricing remained under pressure in spite of the significant technical and operational challenges in this market. The resulting business environment is potentially becoming unsustainable for us and will either lead to a recovery in service pricing or a narrowing of our service offering with re-deployment of resources to markets that offer more adequate returns.
• In Latin America, revenue declined 4% sequentially driven by Mexico where budget constraints impacted activity and Argentina where unfavorable whether conditions and union action disrupted activity. Ecuador remained strong as did Colombia
• In the Middle East and Asia, revenue increased 5% sequentially driven by strong drilling and completions activity on land in the Gulf region. At the same time activity in Asia weakened further in the fourth quarter, but now appears to have bottomed out and we therefore expect a slow recovery to start also here in the coming quarters.
• As we now move into the recovery part of the cycle, I would like to turn to the developing macro-environment and what this means for our business. First of all we maintain our constructive view of the oil market as supply and demand continued to tighten in the fourth quarter as demonstrated by the OECD oil stocks, which declined for the fourth month in a row in November. This tightening is partly driven by strong demand where the reporting agencies revised their global demand growth figures upwards in the fourth quarter, and now stand at around 1.5 million barrels per day in 2016 and between 1.3 and 1.6 million barrels per day in 2017.
• From the supply-side, non-OPEC production remains under pressure seen by the large year-over-year drop in North American production, which as of December had fallen by more than 600,000 barrels per day versus 2015. Over the same period new production from the completion of long-term large projects in Brazil, Kazakhstan and Russia was offset by falling production from Mexico, China and Colombia to result in a year-over-year reduction of 900,000 barrels per day for non-OPEC production.
• In terms of OPEC supply, production surged to record levels in the fourth quarter to meet the increase in demand and to offset the falling non-OPEC production. This lowered spare capacity down to 2 million barrels per day in November, which is barely 2% of global production represents a 12-year low. The OPEC agreement to reduce production by a significant volume of 1.6 to 1.8 million barrels per day has now established a floor to the oil prices and should accelerate the tightening of the oil market going forward.
• These supply reductions will take a few months to work their way through the distribution system, but we expect to see an acceleration of global stock floors towards the end of the first quarter. Meanwhile over the next several months, oil prices are expected to fluctuate around current levels until a steady reduction in crude inventories is fully established.
• As the up-cycle begins, growth in E&P investments will be led by the North America land operators who appear to remain unconstrained by years of negative free cash flow as external funding seems more readily available and the pursuit of shorter-term equity value takes precedence over a full cycle return.
• E&P spending surveys currently indicate that 2017 North America E&P investments will increase by around 30% led by the Permian basin, which should lead to both higher activity and a long overdue recovery in service industry pricing. In the international markets, the recovery will start slower driven by the constraints of the international E&P industry where the various operator groups determine their investment levels based on full cycle returns and their available free cash flow.
• At current oil price levels this will result in the third successive year of lower Capex spend, which will further weaken the state of the international production base…This is equivalent to borrowing barrels from the future. As a result, the activity and Capex required going forward to replenish reserves in order to uphold production for the medium to long term will be much higher than the current decline rates may suggest. This concerning trend cannot be reversed or mitigated by North America unconventional resources alone, which currently represents only around 5% of global crude production…The future supply challenges of the industry can only be addressed by a broad increase in global investment. Therefore as international E&P cash flow improves in the coming quarters we expect to see E&P investments accelerate in all main producing regions leading into 2018.

• In addition, we are now requesting pricing increases on contracts where the efforts we have made have helped bridge the trough of the cycle for our customers but where the contract holds no promise of delivering the returns we would expect in the current improving business environment.
• But what is fair is that the recovery is on unexplainable market and all markets have now reach the bottom including Sub-Sahara Africa and Asia, so I would say excluding the seasonal slowdown in Q1, it should be up from here in basically all markets, but the pace and the timing is still somewhat uncertain.
• Now, I think the key here is that we look at 2017 as a starting point of a new multiyear cycle, where the main challenge is actually going to be reverse the effect of several years of Global E&P underinvestment and then try to mitigate the pending supply shortage that we see unfolding. But the only way to achieve this is through broad-based increase in global E&P investments as North America and non-conventional production is not going to be able to address this pending supply issues by itself.
• I really feel comfortable that the price of developing deepwater projects is down substantially. And I think every basin and every reservoir is slightly different, so I’m not going to go into breakeven prices, but what we’re seeing on a regular basis is the ability to unlock developments that were there before.
• I’d like to summarize the key points that we’ve discussed. First, the market recovery is clearly on its way and we look at 2017 as the starting point of a new multi year cycle that will require a broad based increase in E&P investment in order to reverse the effect of several years of global under investment and mitigate the pending supply shortage. As all cycle will initially be led by North America land, but followed by the international markets later in 2017 and leading into 2018. 

 

Baker-Hughes

On January 26, 2017, Baker-Hughes held their Q4 2016 earnings call. EPS was 0$0.30 per share on revenue of $2.41B (-28.9 Y/Y). Revenue for North America was up 15% sequentially. CEO Martin Craighead stated the following key points:

 

• Next, let me turn to the market outlook and how we are positioning Baker Hughes for success. It is clear that the market is in a healthier place as the result of a number of significant industry changes that have occurred over the past several months. However, while there is reason to be optimistic, there remain a number of factors that could cause the expected recovery to occur more slowly and less smoothly than some anticipate. I'd like to walk you through our rationale for this view.
• In October, we said that a series of milestones needed to be reached in order for a broader recovery to take place and before market predictability could return in a meaningful way. First, we said the supply-demand surplus had to rebalance, allowing commodity prices to improve. Since October, two things have materially changed. We've seen OPEC's decision to scale back production, and we have seen forecasted demand for 2017 to increase by 1.6 million barrels a day. Taken together, and adjusting for drawdown of global inventories, this would point toward a balancing of supply and demand in the second half of 2017.
• However, as we also said previously, the North American shale segment remains a wildcard in all of this. Since details of OPEC's plan surfaced, rig counts have increased by 33% in the United States, with over 170 rigs added and a corresponding increase in U.S. shale production already underway.
• Second, we said that commodity prices needed to stabilize for confidence in the customer community to improve and investment to accelerate. We continue to believe that North American operators need sustained prices in the mid to high $50 range for this to occur. The North American shale operators' ability to rapidly increase production has resulted in commodity price recovery being shallower than expected, bringing uncertainty to the sustainability of these recent price increases.
• And, third, we said that activity needed to increase meaningfully before excess service capacity could be absorbed and pricing recovery could take place. We have seen the first signs of this in select product lines in a few of the North American basins, but I still believe there remains a fair amount of capacity that must be absorbed before service pricing will become more tightly correlated with higher commodity prices and increased activity. With this backdrop, it's clear the market has taken a positive turn, and we have all the elements in play for recovery.
• Turning to international markets. We expect overall activity to be flat to down in the first half of the year, with upwards movement in the second half. We will see pockets of continuing growth onshore that we intend to leverage. In contrast, we expect offshore markets to remain challenging throughout 2017, but as demonstrated by our recent contract wins, we are very well-positioned to capture opportunities as they arise.
• [Speaking about Deepwater recovery]:   But, as we said back in the third quarter, and we're holding to that, for our offshore IOCs, it's got to be north of $60, probably north of $65, to encompass the majority of them. And it's got to hold there for a while. Now, it varies. Certainly, deepwater West Africa has a different profile in terms of customers and also the risk appetite versus, let's say, the more mature North Sea basins. And of course, as you well know, it's just a longer cycle commitment, and that's where the durability of these commodity prices just have to hang there for a while – and again starting with a 6.
• [Interesting discussion on Mid-East growth for BH and OPEC Cuts]:  There's a bit of a disconnect between the OPEC cuts that were announced and what we're forecasting at least for the next six months in terms of activity. And I have to hand it to our customers there. The governments have long-term strategic plans. They keep their NOC subsidiaries kind of on notice that they want to have a certain production capacity. Some of our Middle East countries and clients have not wavered from their long-term 2020 or 2025 production goals. So we've seen no pullback that would kind of correlate, if you will, to the announcement on a production cut. We still expect it to be relatively steady and a couple pockets, so some of the more midsize to smaller players in the Middle East are actually going to increase. So it's a positive environment, at least for the first half, in that region.
• [Speaking about international service pricing]: No. There's no pockets of improvement internationally. I mean, it's – not in the first half. And it gets back to what we see with regards to commodity prices. But everything starts in North America and kind of ends in North America. And, as I said, we're kind of at the end of the downturn. We're starting to – I think we're on the cusp of a sustained recovery. The question is timing and intensity, but it's certainly looking a lot more positive. That washes to the other shores where we work and the clients' own changes. Certainly, our customer communities in the Eastern Hemisphere has a different tone. They're more optimistic. But, again, it gets to the longer-cycle nature. And we got to see capacity get absorbed in North America to where it starts to really tighten up the conversations in the Eastern Hemisphere. But I'd say the pricing in the fourth quarter in the Eastern Hemisphere is probably the worst I've ever seen potentially that I can remember. Let's put it that way.
• [Speaking about moving equipment around]: Now, you have longer-term contracts and so forth, but this industry needs to have more discipline when it comes to return on capital. We do certainly as a company, and we're not shy about having the conversation with our customers that equipment needs to go where it's loved the most, and that's why I think that North America could be a catalyst sooner rather than later with regards to what's going on in the rest of the world, and I – appreciate, I can't give you specifics of where things are moving right now. 
• [Speaking about customers trying to get long term service contracts at lower pricing] We look at each one very closely, and we're in general avoiding that type of outcome. If it does have that in this particular environment, then it has kick-out clauses or escalation opportunities. But, yes, there is a bias in the customer community now to try to button down service agreements for the longer term. And in general we're not biting.

 

Halliburton

On January 23, 2017 Halliburton held its Q4 2016 earnings conference call. Halliburton reported earnings of $0.04 per share on revenue of $4.02B (-20.9% Y/Y). CEO Dave Lesar made the following key points:

• Never before in my nearly 40 years in and around the oil and gas industry have I seen a more difficult year for the industry. The down cycle in the 1980s was bad, but 2016 represented the sharpest and deepest industry decline in history. However, today, I’m really excited about what I see happening.
• Despite the positive sentiment surrounding North American land, it is important to remember that our world is still a tale of two cycles. While the North America market appears to have rounded the corner and is on the upswing, the international downswing is still playing out.
• Let’s talk about North America. On the second quarter call, I told you that customer animal spirits were back in North America. Last quarter, I said that these animal spirits were alive, but somewhat caged up. Now, these animal spirits have broken free and they are running. However, not all customers are running in the same direction or as a pack, but they are running. 
• So, as I look at 2017 in North America, I really like how it’s shaping up. I expect as we finalize the execution of our strategy that revenue will meet or exceed rig count growth in 2017. However, we will have to contend with the cost of reactivating frac spreads and inflation on our inputs. Keep in mind that our suppliers also expect to benefit from our customers’ animal spirits.
• So, let’s turn to the international markets. There pricing and activity levels remain under pressure as we near the bottom of the cycle. Low commodity prices have stressed budgets and impacted economics across the deepwater and mature field markets, which has led to decreased activity and pricing throughout 2016. These headwinds still persist today.
• Now, there has been a lot of debate as to what commodity price will reactivate the higher cost basins, such as the deepwater complex. It is clearly higher than the price that we are seeing today. Also impacting the price will be OPEC compliance with its new production guidance. Most people agree that the U.S. is now the world’s swing producer and it has demonstrated its ability to ramp up production quickly at a price that may make it difficult for deepwater projects to compete.
• We believe that the race to get deepwater project cost down versus the impact on commodity prices on increasing U.S. shale production will have to play out over the course of 2017. Therefore, we do not expect to see an inflection in the international markets until the latter part of 2017. In the meantime, our international customers remain focused on cash flow, and traditional contracting cycles will likely mute any dramatic rebound coming off the bottom. We expect revenue and margins to slowly grind down during 2017, as the market seeks to stabilize.

 

Other comments of interest:

• Turning to downturn, our industry went through a steep regression in profitability as pricing and activity declined. The industry moved from positive operating margins to negative operating margins and into negative EBITDA and ultimately round up struggling to cover variable cash costs. It was a fast and hard road that caused a dramatic shift in landscape of the service industry and wiped out a significant amount of shareholder equity.
• The pricing brawl continues as the industry recovers and equipment availability tightens. Pricing at the margin is ultimately set by whoever is satisfied with the lowest returns. It’s important to understand that our competitors’ motivation from margin returns is largely built around where their pricing is anchored today. For example, if they are at negative variable cost, then they’re trying to get to a negative EBITDA. If they’re at negative EBITDA, then they’re trying to get to negative margin and so on. I can tell you, despite what you hear in the market, it’s clearly a bridge too far to skip from negative variable cash to positive operating margin in one step. So, the industry pricing regression I discussed earlier needs to become a pricing progression. This means that for now Halliburton will have to compete with companies that are satisfied with lower levels of short-term profitability. But, we don’t believe their pricing is sustainable. You can’t have negative margins forever.
• Let me give you an anecdote. I was talking to the CEO of one of our IOC customers Friday, obviously not going to say who it was. And he said that there was not a single asset in their portfolio outside the U.S. that competes with their U.S. opportunities right now. And to me that’s a pretty amazing statement to me in terms of really how much further commodity prices have to go up to bring some of these more either highly complicated or longer duration projects to the front of the queue get an FID decision made around them.

 

Weatherford

On February 2, 2017, Weatherford held their Q4 2016 earnings conference call.   Revenue grew by 4% sequentially. North America revenue grew 8%. Weatherford detailed their debt restructuring and which parts of their business they are selling or deactivating. During 2016, Weatherford shut an additional 5 manufacturing facilities, bringing the total to 15. They plan to close another 4 in the first half of 2017.

Weatherford did not provide many forward looking statements, rather, they focused on reducing their debt and the transformation of the Company. In particular, they focused on what assets they are selling off, what business lines they will and will not engage in in the future. If you do a substantial amount of business with Weatherford, I would encourage you to read the transcript available here: http://seekingalpha.com/article/4042005-weatherford-international-plc-wft-q4-2016-results-earnings-call-transcript?part=single

 

By: Ty Chapman
Five Star Metals, Inc.
Raising the Bar for Customer Service and Quality
Twitter: @FSM_TY

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