Liberty Energy Inc. (LBRT) Earnings Call Transcript & Summary

Hi. I'm Sean Meakim, the oil services analyst at JPMorgan. Thanks for joining us for the fifth annual JPMorgan energy conference. Up next, we have another fireside chat, and we're very happy to have Liberty Oilfield Services back at the conference with us. Liberty is a pure-play pressure pumper with leading market share in the Rockies and strong exposure in the Permian and Eagle Ford. The company has shown a relentless pursuit of efficiencies by leveraging technology and data analytics that contributed to peer-leading profitability and returns in the last cycle. We're fortunate to have Co-founder and CEO Chris Wright join us today. Chris, great to see you, as always. We saved you the plane and the hotel this time, but great to have you back again today.

Great to be here. Great to be here. I appreciate all the participants accommodating the format.

So great. Let's kick things off with that.

To start. When you reported earnings in the fourth quarter in February, your crews were breaking records in terms of volume pumped at that time early in 2020. And then we go to your first quarter call in 1Q in April. Demand was evaporating. And now where we stand in June, at least in terms of the equity markets, I think we're back. It feels as though we went through a full cycle in just a couple months. And so just given the unprecedented drop-off in activity that the industry has experienced in the current quarter, can we just start in terms of what you've witnessed, how things have progressed from last time you spoke to investors on the call to where we stand today kind of wrapping up the second quarter?

You bet. Well, I -- your comment. The equity markets thinks things are back is further proof of their discounting mechanisms looking into the future. And sure, things have unfolded reasonably along the line we thought in our conference call, which was more than a month ago. And those oil prices and at those differentials that existed in the basins, it made sense for players to dramatically reduce activity and in a lot of cases to just cease activity. You're shutting in a bunch of production. Why should you be prepping new wells to come on production? So things have dropped to a very low, low. And then -- but all our dialogues now are about when are people restarting up and when are they expanding their plans. We've been having those dialogues since the beginning of April, so it's just been a continual dialogue with our customers. And yes, I think we've seen the bottom, and we see a reasonable trajectory of slow but steady improvement going forward.

So let's talk a little bit more about your plan of attack during this low period of activity. So you talked about first time we've had to lay off folks in the history of the business but also learning how to keep this core talent in order to be able to regrow off the bottom. So you elected to keep 12 fleets active. You're furloughing crews in order to kind of keep folks in the mix, give you optionality when things get better. Can we just talk about how that process has gone and how you see that helping the business as you get to the back half of the year?

We've communicated a lot in our company both with e-mails company-wide. We had another happy hour last Friday, Zoom happy hour with a huge amount of people. So our company, as you know, is very much for this big family culture. So we've communicated since the start of what's happening how we think things might transpire. We've got a furlough system right now which is very variable on cost structure. Our cost structure flexes with our activity level. People get that. They understand that. And yes, well, I mean, if crews are working, everybody is fired up and excited, but if your crew is not working right now, we're in constant communication with you and with those customers and as those crews come back on. And in G&A and overhead, it's the same thing. There's degrees of cuts based on our activity levels. So it's all -- we're all in the same boat together, and what makes it work is that alignment of our interest and that alignment with our customers. They want Liberty around and strong and just as good. As we shrunk the company, all the service leaders in our company, the people who rose up and lead the crews, almost all of them are still here. So yes. And performance of crews today is off the charts because they're run with huge concentration of supervisors and leaders. Look, given all the world is throwing at us, I think things are going very well right now.

And so then from an investor perspective, how should they be translating that into their expectations around fleet profitability second quarter and back half of the year? I recognize there's still a lot of uncertainty around where activity goes, but just what's kind of the -- where -- how do you kind of keep people in the fairway around profitability expectations?

So look, the key thing for us in a downturn, #1, is protect the health of our employees. That's a different one this time. Protect the health of the company, protect our relationships with our key long-term partners and look to build or expand our competitive advantage. And that's what we're doing, but when you're in a crazy low-activity market right now, there just isn't that much work, so if we wanted to maximize the number of fleets we're running, we'd have to go after all sorts of customers that aren't even Liberty partners right now that apparently didn't have a very tight partnership because they're just bidding it out on the spot market to see where they can get the cheapest work. That's just not the game we play. So we're in those dialogues to know what's going on, but we're not going to pick up people just looking for the cheapest back player. That's just not what Liberty does. I would say our more important game in this downturn is to grow our market share with our most important customers, some of who are bigger companies. So they're using other providers or at least another provider. We want to say, hey, this is a good time for Liberty to take a larger piece of whatever that pie is for performance reasons, for technology reasons. And I think that's going pretty well. So we've preserved and in fact grown market share with all of our key partners. Now their activity is very low. Our activity is very low, but we're okay with that. So Sean -- and yes. So we're not going to -- as you said, if you're in the spot market today and you want to be the winner, the low-price winner, that's way negative EBITDA. That's terrible profitability, but that's just not a -- it's just not a game we're playing. We're not making a lot of money right now. I don't, by any strikes, nor are our customers. We're just getting through and preserving those relationships and trying to, as we've said all along, the -- we're going to end the -- we're going to build cash. We're going to end the year with more cash than we ended Q1. We're going to end the year with more cash than the downturn start, which we call end of March.

Right, right, very fair. So then as we think about translating that into what we're seeing in the near term. So from a macro perspective, oil prices have bounced back rather dramatically. We've seen production get shut in, but now we're seeing production start to come back online. How are those customer discussions evolving in terms of -- we've seen third-party indications of frac activities starting to pick up a little bit, right, on anemic levels, but still directionally things at least seem to start to be going the way that I think folks were expecting in June. Rig count declines, at least they're starting to decelerate. Maybe we're getting towards the later stages there. Just curious how all that translates into how you see the back half of the year. Can we see activity get to something that's palatable? Or is it just going to be different degrees of bleak for '20? Because to some degree your customers are also going to want to have an impact on production for '21. If they're going to try to stabilize their production profile, some of that work will probably need to get done in the back half of the year. So just curious how you see those moving parts and, specifically in your customer discussions, how those have evolved.

Yes. Great, Sean. And those have been excellent. Again one of the things I think you see in crisis, when everything -- when times are good, everybody is nice and everything feels okay. When crisis happens, you find out what people's real character are. You find out what relationships are strong and what relationships were convenience. And I've been thrilled by the way people within Liberty, in our suppliers and in our customers. Our customers have just been brutally honest. "Here is what's going on. Here is what we're seeing. This is what we're planning to do. Here is why we're planning to do." I -- you know me. I ask all sorts of questions. They've been super honest. We've had fantastic, candid dialogues. I'm the -- also Chairman of an E&P company, so I'm seeing the same things. We had a time where not only were oil prices were low, but differentials were blowing out everywhere. There just wasn't demand for crude at refineries. There were struggles. That changed. First, the differentials changed. The differentials contracted, then prices responded. So yes, you're seeing the shut-in production coming back now just by pure economic reasons. Wellhead prices have moved dramatically, yes. And I and customers worry, no doubt, they'll move too dramatically. We want to -- with the shrinkage of demand, we want a contraction of supply, but we are seeing that shut-in production coming back. I think we'll see a lot of it if -- most all of it back by the, say, end of next month. So there's still a lot still shut in. Frac activity probably bottomed in late March. So I always say our mentality is more impacted by the rate of change than the state of play. So the state of play is terrible and very low right now, but it's getting better. We got some new activity, have started. We'll get some more stuff to starting in -- that start in July. We've got some stuff that will start in August. We've got a few things that are starting in September. So what we see is sort of a palliative just of increasing activity but modestly increasing activity. At the end of the year, will we be back to where we were before? Nowhere near. I think, the total fleet count active in the country at the end of the year, it'll still be less than half of what it was before the downturn, but as far as production, Sean, that is what everyone is talking about. Kind of what are their returns? Why does it make sense for them to do, as far as pace of activity, where that activity is, how they might change frac designs, how they might change strategy because input costs are different? Commodity prices are different, so optimization is a moving target. But by our math, just in the oil basins, all of the oil basins, you'll probably need about 175 fleets for flat production, to hold production flat. And that's at an assumed flat level, which is we're guesstimating production to be late this year. So are we going to be at 175 fleets at the end of the year? I think, highly unlikely. So I think we'll probably still be at a level of activity that is causing U.S. production to contract at the end of the year. And then '21 is still up in the air, as far as what people are going to do, so I don't have any meaningfully better insight there than anyone else. Our guess is sometime in '21, we'll get to a fleet count that keeps production flat. And then if oil prices are $40 or $42, we'd probably -- there's no reason to go beyond that. We may not even get to flat if oil prices are stronger and returns are pretty good. I think you -- we may see a fleet count go to some modest growth rate pace, but believe me: Our customers in Liberty, the biggest problem we have last decade, our industry had awful returns on capital and therefore awful returns to our owners. That's horrible. So I think there's a large focus on we need to structurally change our business so that there are real returns on capital. We feel players are going to go away or are going to fall out, and that's unfortunate, but that's how markets work. That's Schumpeter's creative destruction of capitalism, but I'm actually pretty optimistic about the next few years in a smaller, slightly more consolidated industry with different players. But I think we'll, hopefully, see the cure we all need.

That's really helpful. I appreciate all that context. Should investors expect much out of the liquids basins outside of the Permian? In a 40s world, is that enough? Do we need to see 50s to get things restarted up North?

No. The -- it's a pallet, right? There's the core of the Bakken, the core of the DJ. They're awesome. They're just much smaller than the core in the Permian. And differentials are larger. So in a downturn, differentials blow out there first. And when prices collapse and differentials collapse, activity just shuts in. Differentials come back meaningfully, meaning contracted meaningfully. So no. I think, if you've got a bunch of DUCs sitting there that are in very good wells, it's meaningfully cash flow positive to complete those wells. So we'll see first in -- the activity certainly will pick up strongest in the Permian, but you'll see some pickup certainly with fracking of DUCs coming on in the next few months in other areas in the Rockies at a low level but above the bottom that we hit but at a low level. You -- I think you need oil prices 50 or so to really add rigs, but right now you've got a bunch of wells that you've already drilled. They're sitting there. You've got pipeline hookups. So it's a lower bar to complete those wells and bring them back, but again, everyone is doing the math. "What does that mean for my returns, my completions, my cash flow?" So I think similar trajectory but more muted and probably a little more delayed than what happens in the Permian.

All right. So then we often talk about this idea of more pain, more gain in the sector; and less pain, less gain. So on the one hand, no doubt we're going through a lot of pain. The equity markets price is in a lot of pain. And to your point, they've now priced in some kind of normalized activity level that's beyond where we are today. How do you think about the likelihood of that consolidation phase that you talked about among your competitors in terms of both some -- potentially some liquidation, some equipment leaving the market and some consolidation within players that survive? Liberty is going to be one of those on the other side of this. And so to some extent, more pain leads to potentially more gain on the other side. Is -- are there risks that to some degree, as painful as this has been, it's not painful enough for the industry such that the market structure looks pretty similar next cycle? Just curious about is it more of just a duration issue. The longer we stay at low levels of activity, that's what drives more capital and equipment out of the market. Curious how you see that shaking out. It's something we've been talking about for probably a decade about the consolidation of this frac market.

Absolutely, Sean. And as you and I talked probably just a couple months ago or maybe 3 months ago, before COVID hit, our take was it's probably 1 or probably 2 more years of a grind to get, to push capacity out and get to better structure. We're hoping and, I suspect, what's happened here in this crisis is a little bit of a fast-forward button on that. So yes, rebound in oil prices, rebound -- do we worry about not enough pain? Absolutely. Believe me. Our -- everyone is worried about that a little bit, but I think our worries are probably a little overbaked because, looking forward, yes, you probably know on both the customer and the competitor side who the survivors are then who are the thrivers, and how does relative market share and competitive advantages shake out through that? Maybe that's -- only becomes more clear with time, but as I said, look, I think will -- the world will feel -- for us in the Liberty world, the world will feel a lot better in December than it does today, a lot more crews working. We'll actually have some new technologies that will -- were starting to play a role, but at that time, the demand for fleets is still going to be less than half of what it was. So if you were a player that you're with partners, your dance partners were the people that couldn't get the better providers and they're just still looking for low prices and they're not really your partner, things are going to be pretty awful in the frac world. Right now -- and I always answered too longly, but when you have to push fleet out of the market, that's what pushes prices down, all right? So when they're -- actually, 2 months ago, you had 300 staff fleets. And as that demand dropped, dropped, dropped and dropped way below 100 fleets, people -- I want to keep my fleet going, so people putting these just crazy prices to try to keep that fleet alive, well, the only guy who wins, wins at such a price that he loses money faster than the other guys. So do you really win? But the others do indeed eventually lay those people off and park those crews. So the decline of active fleets is the brutal part on pricing, in pricing. So that's what's probably still going on, but so many fleets have been idled and people have gone. But that's what drives frac pricing down. And then we're hitting an incredible low, but as you go from here, first, you've still got some fleets that are sort of warm. The guys are around. So you'll have one level of pricing to add those additional fleets. We usually hit that in the fall, then activity levels is higher than anybody's got fleet staffed for. That's still a low level, but those fleets aren't staffed. Nobody is going to hire people back and restart everything for a lousy pricing, so I think you'll start to see pricing bouncing back a little bit this fall and into the end of the year, not a lot but a little bit. And then we'll have some -- probably some meaningful price momentum early next year, again from a very low base. But yes, people that didn't have strong partners -- their partners are consolidating or going out of business or are always just going to be the cheapest commodity players because they're state buyers. They're stating on the edge. I think, the companies that, that's the customer base, they're going to go away or shrink dramatically. So I still think we will see the fast-forward button. And 12 months from now, certainly 18 months from now, I think we see a meaningfully different supply-demand balance in the frac world. We're pretty optimistic.

So I appreciate all that detail around the supply. Let's talk a little bit more about demand from a macro perspective. In '16 through '19, most of the incremental barrels were delivered by shale, 1 million-plus growth rates each year. And so there's some burning debate around capital constraints. And there are even just preferences among those who have the ability to flex short- versus long-cycle projects. Does that look different? Is the appetite for short cycle where you're on the cash flow treadmill, the reinvestment treadmill, does that look different? And does long cycle all of a sudden find some new appeal after being out of favor for a while? Just curious on your overall view of how that can look. Just the Chris Wright view are one that I think is so fairly informed, particularly around energy transition and how things can unfold and from a demand perspective for oil. So how does that come back to your view of expectations around the call on shale next cycle, which obviously has a big impact on what the -- what this demand high looks like for your business?

Yes. And Sean, I think that's the big key is nobody really knows the demand for oil over the next few years. So bouncing back pretty quickly now, but when do we even get back to where we were pre COVID? I guess that's maybe late next year or sometime, could be longer, could be sooner. So it depends where that is, but the long cycle versus short cycle sort of the treadmill line, I actually have a different view of it. I actually view it as a positive. I always say, if you were going to build apartment buildings or any -- another long-lived asset, would you rather have your rent payments accelerated upfront? Or would you rather have them stretched out over time? For present value, you'd think you'd rather have them accelerated both for the same dollar is worth more and also for flexibility. I want to know -- I don't want to know 5 years after I built a lot of back-ended-weighted apartment buildings that nobody is going to be in them. They're not going to be full. That's disastrous. I want to know quickly what the trends in demand are for the assets I'm building when I'm deploying capital. I want a shorter return on my capital. So as you think shale is advantaged in that case, it's just easier to make decisions. Now have bad decisions been made in the last decade by American shareholders? 100%, 100%. So that leads to all the negative adages about, "The treadmill, this doesn't work." Well, people have -- many players have made it not work, but by nature, it's a better structural set for investment than long cycle because long cycle -- geez, I'm not even going to get any revenue for 4 or 5 years. You and I are struggling with what oil prices are going to be a year from now. What are they going to be 5 years from now? I don't know. And there is actually a pretty wide range of there from a reasonably bullish outlook to a more pessimistic outlook. So no, I think shale will probably still be a meaningful supplier for the marginal barrels. In fact, I think one of the stories is we're going to see significant destruction of supply from this downturn, meaningful. I mean, of course, we're already seeing that in nations outside of this country that were living rent-seeking off oil prices way above their production costs, but they build it into their societies, their social structures. Their ability to stay in power is that large oil price premium. They've been rocked. I mean Iraq is in trouble. Nigeria is in trouble. Algeria is in trouble. Angola is in some trouble. Venezuela, speaks for itself, [ are rocked ]. So I think we may get to a situation where sort of the oil supply we've generally counted on that's been part of this oversupply mix -- some of that's -- capacity is going to shrink. Some of that's -- capacity is going to shrink. You can make a case that sort of the outlook for oil prices over the next 5 years is meaningfully more bullish than it's been over the last 5 years. I don't think anyone should bet on that. No one should invest on that. And I don't think in our space they are because you don't need to, short cycle. We'll see that story unfold, but I think, as a marginal barrel that come into the marketplace, I think there's still a pretty big role for shale. I think a very big role for shale. My -- but again I do think you'll see U.S. production continue to decline. When will U.S. oil production get back to 13 million barrels a day that we were at, geez, just 2 or 3 months ago? That could be a few years. That depends on prices and returns, not -- and not just prices but also cash flow. People are very focused. Even if my returns are strong, people aren't going to issue new equity to grow shale production. I mean everybody did that. Everybody is angry about that. Like I don't see you're seeing a return to that. So if oil prices are higher, people's cash flows are stronger. They'll keep their free cash flow still up there, but could part of that incremental cash flow go into incremental investment? Sure, it will, but I think you'll see reasonably disciplined investment across the U.S. shale sector because the -- a number of the undisciplined players won't be around or won't have access to capital or be consolidated. So look, that means again a slightly smaller service market than in an undisciplined world but, I think, a better place, a better place for our customers and therefore a better place for us. I wouldn't write off shale. I think it's going to be key. Last thing I'll say, Sean: From the Energy Information Administration, right? They released their data maybe 8 weeks ago for 2019. In 2019, the United States share of the energy that we consume that came from oil and gas was the all-time high, all-time high. Almost 70% of total U.S. energy consumed in the U.S. came from oil and gas. So the energy transition, what's happening in market dynamics there is coal in the developed world and in the United States has shrunk pretty rapidly. And maybe 60% or 65% of that gap has been filled by natural gas, and maybe 30% of that gap has been filled by renewables. Now from renewables, a relatively small source to fill 30% of the goal -- gap, with coal declined, that's a lot. There is rapid growth there and all that, but is the market share or demand for oil and gas meaningfully shrinking because of changing energy sources? Not yet, not yet.

Right. So that's a really helpful framework. And so we've done a lot of work similarly looking at what next cycle could look like from kind of the bullish to the bearish. I mean just maybe, as you think about that, I mean, it seems like the downside risks are more demand-driven, but the upside risks are more supply-driven; oil supply versus oil demand. So as you think about next cycle, what would be your vision of what normalized activity looks like or profitability just in terms of looking out on a 3- to 5-year basis? What does that opportunity set look like for your business in North America?

Yes. So I'm smiling inside at that normalized profitability because nothing is normal or steady in this industry, but I know what you mean by normalized, which is average through a cycle. And yes, I think that's hard to say. The last -- we've been in business. This is our, what, ninth year generating revenue and business. We've had a well over 20% cash return on cash invested over those full 9 years, and those have been a pretty bad 9 years for our industry. So the next 5 years, well, I would say the next 5 years are likely to be better than the last 5 years. Now will they be as good as 2012 -- '11, '12 and '13? I don't know. Probably not, but they'll probably be better than the last 5 years. That depends on what -- if the capital markets stay as close as they are today and certainly in the service space. Selfishly, I hope that's true. We are a self-funder and we've nearly always been one, so -- but I think that the capital -- the lack of capital availability will crimp investment. Even without company failures and people scale along and they continue to run their equipment, they need meaningful reinvestments. What -- we call that maintenance capital. You've got to replace the engines. You've got to replace the power ends. You've got to replace the transmissions. Most of our competitors have for years not generated the returns to generate that capital, to generate those investments. So I think we'll still see this meaningful bleed-out of equipment. I also think, Sean, you're probably going here in the Q&A, anyway, I also think we're seeing among the bigger players and the stronger mid-caps that -- this desire to be cleaner and better and more efficient, not just do the right thing for the neighborhood but it appeals to investors, that of course is growing too. And these are what we call next-generation fleets, like Quiet Fleets, like Tier 4 and Tier 4 dynamic gas blending, like electric frac fleets; just lower emission profiles, lower sound profiles, lower dust profiles; faster to get stuff done. So I think we're going to see more -- as the bigger, stronger players in the E&P space become a larger percent of the market, the demand for that kind of equipment is going to be a larger and larger share of the demand-pull for frac services. And most of the competitors just are not going to go there. They won't have the capital, the return. Some of them, the technology are savvy to do that kind of stuff. So I think that becomes sort of a tailwind for supply and demand in our marketplace, but it is going to be a pull on investment capital. And for us and others to do that, it's got to make sense to do it, not because it's fashionable, not because people will smile more but because our customers want it. They're committed to it. And we'll make a mutually beneficial arrangement where it's good for them but the economics justify the investment for us.

That's right. And that was the next point. I think it's important to touch on, that call on lower-emission equipment next cycle. So in the interest of time, to just kind of wrap up, I want to just make sure we touch on cash flow and the balance sheet, big effort on reducing maintenance capital. It would be great to get an update on how successful you've been there. And then last, just you've been a countercyclical investor. We've spent a lot of time over the years talking about capital allocation and kind of going -- not being procyclical in terms of your investment strategy. Were there another downturn, just curious. Balance sheet is in great shape. Would you consider issuing equity for a larger transaction? Just what types of consolidation could make sense for Liberty? If neither things ends on that, I think.

Great. Well, on the first one, look, yes, there's 2 things that are driving down maintenance capital. One is a looseness of the market so components and parts are cheaper. Now that's a cyclical one. The secular one is we have invested, and we don't talk about it very much, on technology there. How do you make the major components of a frac fleet last longer, cheaper and just simply smarter design? So yes, we are continuing to work on that. We're making some meaningful progress there. So yes, I think -- certainly in the short term and over the longer term, I think we will see a reduction in maintenance capital. On the acquisitions, yes. Look, we're these odd ducks. We do things a little bit differently. We invest a little bit differently. We're not a -- our play is not a roll-up, but when might consolidation be compelling? Yes, it's in the times we're in. I mean we ended up doing that deal, as you're well aware of, in '16. This is a similar marketplace with a huge amount of stress, so who knows? But if there is a time where something like that that's compelling comes about and makes sense -- I mean it's far more likely this year than it's been for the last several years, so who knows? We're always looking. We're all thinking, but for us to do something, one thing drives us. It's to grow shareholder value. The only way I make money in this business, it's not a salary. It's just about shareholder value. I've been that way my whole life. So we look at everything through that lens. And if we can find deals that grow our shareholder value in a pretty compelling fashion, because there's always risk, we would do something. And it's who -- we haven't done a lot. And it may not be -- do you like that, but it's more likely now than in a typical year.

Right, for sure. Well, it's a great way to end it, I think, so Chris, on behalf of JPMorgan, again thank you for joining us virtually here today. It was great to spend time with you, as it always is. And thanks, everyone, for joining us. Have a great rest of your conference.

Yes. Thanks, Sean. And thanks to everyone who's participated in the JPMorgan conference. And a fantastic conference, and I appreciate everyone's flexibility with the different format. I hope to shake everyone's hand next year. Take care.

Thanks, Chris.