Precision Drilling Corporation (PD) Earnings Call Transcript & Summary

Hi, everyone. Welcome back to the JPMorgan Energy Conference. I'm Sean Meakim, JPM's oil service and equipment analyst. And I'm pleased here to welcome Kevin Neveu, Precision Drilling's President and CEO, back to the conference. Precision's leading position in the Canadian land drilling market is supplemented by a large, high-spec U.S. fleet and a nascent and growing international footprint. The company made significant strides in the last 2 cycles upgrading its rig fleet and diversifying its geographic exposure. More recently, the focus has been on delevering the balance sheet with good success for the last 2 years as well as building out Precision's rig automation capabilities. So Kevin, thanks for joining us today. Glad you're able to connect with us virtually. I saved the plane ticket, but good to have you here. I'll turn it over to you, and I'll come on back on later for some questions at the end.

Thank you very much, Sean. Certainly, we appreciate being here today. And I kind of chuckled when I heard Sean mentioned the last 2 cycles. I certainly lost count of the number of cycles we've been managing through in this oil service space over the past 30-some years in my career. So we're going to be referring to our presentation, which you have access to online. And I'll just quickly go past Page 2, which talks about forward-looking statements, and caution you that certainly, most of what I'll be saying today is our view of the future, and there are certain risks involved with that. You should be aware of those risks. Just turning to Page 3. We remain quite confident, and I think we're demonstrating well during the first half of 2020. And we remain in a position to generate unique shareholder value by focusing on managing our costs aggressively, utilizing our long-life assets and generating free cash flow. I'll speak more to those uses of free cash flow and just how we plan to generate that free cash flow throughout the course of this presentation. Turning to Page 4. Very quickly, land drilling. I think there's a few things that I want to point out here that make land drilling space unique and special in the oil services space. This is certainly an area where scale is critical. The life -- the assets have a very long life, typically 20 to 25 years. We've got a highly variable cost structure in that we can store and rack our rigs and sustain the value of those rigs during the storage period with virtually no friction and no trailing costs. Very high barriers to entry right now, particularly scale, staffing and technology. And there are differentiated services. Now at certain times in the cycle, that differentiation might mean just a few hundred dollars in pricing power. In other times, maybe a few thousand. But there are differentiated surfaces and differentiated pricing. Certainly, we're in a space where our customers recognize and will pay for safety, performance and technology. Obviously, I'll start with a quick update. This is the deepest and hardest cycle of the land drilling space has faced in decades, maybe half a century, for that matter. Activity levels both in the U.S. and Canada are at essentially at all-time lows. The chart from the bottom shows Canadian activity really not yet rebounding off of the typical seasonal springtime lows. U.S. activity piercing down into 280 rig level and likely still a week or 2 more of rig count reductions in the U.S. However, we are noticing a tone change of our customers, and I won't tell you they're going to becoming more positive. They're certainly wrapping up their efforts to reduce activity and they're beginning to look into Q3 and Q4. We actually have potential to see a handful of activations of rigs later in Q3 and into Q4. I think that just speaks to a normalizing of the space right now, but probably a bottoming. We'll certainly know for sure in a few weeks if this is, in fact, the bottom. Just turning to Page 6. We believe we've got a strong track record of delivering on our priorities, and the evidence from 2018 and 2019 is clear. Turning to 2020. Early this year, we stated 3 priorities that we think are cycle indifferent. And the top priority is to generate strong free cash flow and ultimately reduce debt. Second priority is around operational excellence, which I've alluded to already and I'll speak more to. And the third is our technology, which remains an important part of our strategy going forward. On the first priority, generating strong free cash flow, reducing debt. On our Q1 conference call back in late April, we talked about having almost $100 million of cash on our balance sheet. We discussed amendments to our revolving credit facility to maintain full access to our $500 million U.S. credit facility. So I'd tell you that during the period of uncertainty, certainly, that was most of Q1 and Q2, maintaining maximum cash liquidity has been our priority. As we see the market stabilize, we'll continue to focus on managing our costs and managing our liquidity, but we'll again look to managing our debt levels also. Certainly, the cost reductions we've achieved this year have been remarkable. We've guided to cost reductions in the range of $30 million of G&A and 30% reduction in our fixed costs. We've also guided to -- in the range of $80 million to $100 million of cash coming out of our working capital. All of this intended to bolster our cash liquidity. Just looking at the business for just a moment, taking a step back. We added 115 rigs in the first half of this decade, 2010 to 2020 decade. Those rigs are now in a position to generate free cash flow for an extended period of time. You can see that transition happening on the right hand of the slide. And despite activity levels and business coming down in 2019 and 2020, still generating very strong free cash flow. And that's really due to the rigs that are largely new and require just a minimal amount of maintenance capital. You can see here, as we've adjusted our capital spending on Slide 11, that we're expecting to spend less than or around $36 million this year on maintenance capital and probably no more than $12 million on our Alpha upgrades and potential rig upgrades. I'll come back to that in a few minutes. But comparing that to 2019 where we spent $162 million on capital, you can see how we've driven down our capital spending and really focusing on free cash flow. I think this next slide on Page 12 really demonstrates the progress on debt reduction. On the upper left, shows our decreasing annual interest expense. We're probably one of the few oil service companies that's cut its interest expense, not quite in half, but substantially over the past 4 years, while maintaining high liquidity and really doing a good job managing our liquidity -- our maturity profile. In fact, you'll see at the bottom of that slide that the nearest maturity we have is $66 million late this year -- or late next year and then nothing due until late 2023. So a very strong runway right now of maturities. Turning to our second priority, around operational excellence. This is really based on our Super Triple rig fleet, and it really comes from 3 things. On Page 14, you can see it. The first item is our scale. The second is our highly skilled rig crews. And the third is the rigs themselves. I'll walk through each of these and kind of how that plays out in our geo markets. First of all, one of the key elements in land drilling is having a highly trained retained rig crew. And despite the downturn, we focused on maintaining our leadership teams. So right now, while we only have roughly 10 rigs running in Canada and about 23 or 24 rigs running in the U.S., we have rig managers and drillers on hand to run up to 60 rigs in Canada, up to 60 rigs in the U.S. So we believe we can respond quickly to an increase in demand should that happen in the near term or in the longer term. Certainly, keeping cadre of around 1,200 to 1,400 candidates available throughout the cycle is important to meet those rising demand should they happen. So turning to Page 16. Looking at our U.S. market. I think 2 things I'll point to here. One is our penetration of our Alpha technology rigs. And you can see, we have those rigs, the yellow dots, in the Permian, in the Haynesville, in the SCOOP/STACK, in the Barnett, in the Marcellus. And they've also been operated in Niobrara and in the Bakken in the past. And that shows you both the breadth of our Super Series rigs, but also the breadth of our technology offering. And I'll come back to that in a few minutes. I'll also draw your attention to our U.S. market share, which we've driven up since 2014 through the 2015 downturn and now through the 2019 downturn, continuing to gain market share in the U.S. Currently, we have 40 Super Triple rigs idle and available to market. In Canada, similar story. A strong market share growth, really getting back to 2014 through Q1 this year. In fact, our market share has been hovering in the 50% range through Q2. I think that's a bit of a seasonal effect. But it's really driven by our strong footprint in Canada, blanketing the basin, particularly our Super Triple rigs in the Montney and Duvernay field, and again, the penetration of our Alpha rigs throughout the Montney and Duvernay. But we see Canada, despite the uncertainties around Canada, being a strong free cash flow market for us requiring virtually no capital and just generating strong returns on our current asset base. In the international market, we're concentrated in Saudi Arabia and Kuwait. Currently, we have 3 rigs running in Saudi and have 4 rigs running in Kuwait. We have 2 rigs right now that are up for renewal in Kuwait. We'd expected those rigs to be renewed sometime during the second quarter. But with Kuwait in a work-from-home mode, we don't expect those renewals to happen until Kuwait returns to work, which probably will be later in the third quarter or the fourth quarter. So in the meantime, the 6 rigs we have running at international will be stable and strong through the balance of this year and through the balance of 2021 should that be the case. We also operate well service rigs in Canada. We're the largest well service provider. We've been through a multiyear cost reduction effort in that business dating back to 2017. You can see how our EBITDA has risen 2017, 2018 and 2019 despite markets being relatively flat. And starting out this year a little soft. We're still generating positive returns in the first quarter and expect to return to positive returns in the third and fourth quarter once we have through spring breakup. We do believe that the Canadian abandonment program, $1.7 billion, will have a positive effect on this business in the second half of 2020. In 2020, we added ESG activities into our core metrics for our short-term incentive pay. It's become a component of executive comp. We believe we score quite high in all of our ESG activities, but we'll continue to set goals on an annual basis and achieve those goals over a multiyear period. We think the most important element of Precision Drilling for the long term is our technology investments: AlphaAutomation, AlphaApps, AlphaAnalytics. We have 38 rigs in the field right now equipped with and running AlphaAutomation. We have 1 IOC in the U.S. which has adopted the AlphaAutomation older rigs. We have another U.S. driller who has applied AlphaAnalytics to all of their rigs. So I'll speak to both of those. So first of all, on AlphaAutomation, on Page 22. You can see a lot of information on this page. But I think the key is, looking at the box, it says, time savings, nonautomation versus automation. And we're showing here the connection time when you're adding pipe to a well. We're showing how we're saving on the average around 50% of the time about 5 minutes per connection, depending on whether we're in the vertical section, the median or lateral section. And in the bottom charts, you can see how the green lines on the bottom are shorter and more consistent than the red line, slightly above, which is manual. Again, we're saving time for our customers. This is a 10-well study we're showing you here. And we're showing that we're saving about 11% of the well cost for our customer, doing it consistently, predictably, repeatedly. We think that AlphaAutomation is absolutely an enabling technology that allows our customers to drill pad wells cheaper, faster and safer. We believe this is a key technology as we look at a rebound. At some point in the future, we think that Super Triple rigs, Super Series rigs will be the rig in demand and that digital efficiency through AlphaAutomation will be a key distinguishing factor for those rigs. Moving on though. We also have a suite of apps which we are developing and implementing and also marketing now. And in the bottom, you can see a sample of 8 of those apps right now, 9 -- 10 of those apps actually which are moving into commercial phase. We expect all of these apps to be commercial during the course of 2020 and potentially 5 to 10 more apps beyond that. These apps are all designed to improve various elements of the drilling program. Again, saving money, improving consistency and delivering better well performance for our customers that are steering better optimization, better energy downhole. Now turning to Page 24. This is very exciting. This is AlphaAnalytics, and very complicated. What we're doing is we're studying every part of the drilling process with our customers. We're finding ways to help them drill the wells faster. So what we're showing on the left-hand side are 2 charts, 6 wells without the AlphaAnalytics and the 8 wells with AlphaAnalytics. We've driven a 4.6-day savings on 28-day wells. Again, we think this is a strong cost savings for our customers. We believe it's marketable. We're currently in the trial phase both in Canada and the U.S. and believe that this product will move to commercial status by the end of this year. Again, the revenue impacts for these 3 different offerings are a straight $1,500 per day for AlphaAutomation. This is on Page 25. We're charging between $250 and $1,000 per day for apps. And for Analytics, that revenue model is still being worked on, but we believe it will be a strong competitive advantage, helping pull through more rigs, more AlphaAutomation, more AlphaApps and more market share. We do believe we're a first mover. We think this is a very small space right now. We're commercial with both AlphaAutomation and AlphaApps on multiple rigs, multiple customers. So we think we have achieved first-mover status. We'll continue to drive this forward through the downturn and in a rebounding market. So just to wrap up my prepared comments, I'll come back to the slide we started with, which was creating shareholder value on Page 26. We're focusing on generating strong free cash flow. We see multi years of free cash flow by managing our costs down, managing our spending down and really focusing on maximizing the value of the rigs we invested in, in the earlier part of this decade. We're going to maintain a strong liquidity position through the uncertainty period, but we'll look to delever as that uncertainty works its way out of the market. Certainly, our excellence in land drilling will help generate strong market share along with our digital leadership, and we have no doubt this will lead to a higher equity valuation. So on that comment, I'll turn it back to Sean and ask Sean if he has any questions.

Thanks, Kevin. I appreciate that run through. So I agree that Precision has clearly been a leader in terms of the push towards digitalization. Can you maybe just give us a little more granularity of kind of how you're -- what you're seeing in the field? We often will hear anecdotes that it's kind of one rig on, one rig off in terms of getting that adoption for customers. Does -- I think it's this an underlying assumption by a lot of investors that the work-from-home environment, to some degree, has created a greater awakening among the customer base in terms of the potential of remote operations and/or using digital to create better wells. Can you maybe just give us a sense of, on the ground, how your team has experienced that? And thinking about not just the acceleration opportunity, but how may that differs in Canada versus the U.S., or maybe the E&Ps are fairly similar?

Yes. Sean, I think you kind of hit on a couple of key points there. I do think that work-from-home has really heightened in everybody's minds the capabilities of the digital world. And for that matter, managing our rigs on the field and avoiding COVID-19 outbreaks on rigs has been a large part by working with our customers to minimize the number of people who will travel both from the base back of the rig and back again. So we've been doing a lot of things remotely both with video and through our SAP system around cost monitoring and then through Alpha on monitoring operations. So our customers are seeing that value right now as we're trying to limit the number of people that visit the rigs and doing these things with digital technology. So I do think that one of the fringe benefits of this shutdown work-from-home is going to be better adoption of technologies. Now your comment earlier about one rig on, one rig off. I'll tell you, the biggest resistance technology has been right at the rig by people like the company representative of the directional drillers who, frankly, they see their roles being marginalized. I mean the company man's job largely was watch out for our operations to make sure the rig is efficient, make sure the rig is delivering value. Well, if software does that and the company man doesn't have a large role to play, he starts to feel marginalized. And that's been a lot of the pushback. We've felt in the field, and we know our peers have gone through some of the same kind of field resistance. So that company man's job is going to change. He's going to change from being a process manager to a technology enabler. And on the rigs where we've seen that transition, and I commented about 1 IOC in the U.S., in fact, we have 2 IOCs that adopted Alpha technologies. The company men are actually employees of the company, and their job is to enable technology. So very successful with those accounts. We also have this third customer that's standardized AlphaAutomation and AlphaAnalytics on all of their rigs, and that's multiple PD rigs. And they're seeing benefits every day. They're getting those reports on a daily basis, seeing how consistent, how repeatable results are. So I do think that this work-from-home downturn, it's bad for activity, and it's bad for a lot of things right now, certainly bad for the economy. It's been approved to be very beneficial for AlphaAutomation. But there's also a second benefit we found, which I want to come back to. Sean, you'll recall that we have installed the new SAP version of the fleet system we ran about 2.5 years ago. And following that, we are successful in kind of decreasing our G&A, fixed cost staff would support that. But as we moved to remote operations and realized that we could very quickly transition to remote and use our SAP tools to manage our business on a finite basis with excellent transparency right through to the rig, and some of the changes we've made with cost-cutting during this downturn are permanent. Well, the $30 million in G&A savings likely will stay with us even in an up market with the -- what we've learned using SAP remotely over the past 3 or 4 months. So I think this is going to really help restructure our business, not just in the field, but also in the office.

And then are there any significant differences around these areas between Canada and the U.S.? Or is that customer interaction, is that adoption rate fairly similar?

I'd say that the similarity is around field obstruction, both in Canada and the U.S. is very similar. There's no question though that global heads of wells, drilling managers, CFOs, CEOs get the digital-enabled capability. And they're pushing off the top, we're pushing up the bottom. We're converting that middle section over. And it's coming, I think, a little faster now in this downturn. But no difference in Canada or the U.S.

Okay. Yes. That's helpful. And then another interesting topic for the next cycle would be new commercial models. One of your peers has really made a lot of noise around the desire to capture more of the value that they create with their rigs. And no doubt, you believe you would be able to do the same. Just how do you think about viability of new commercial models, again, U.S. versus Canada? How -- What could that -- what could the addressable market look like for those types of contracts? Just curious your take on viability and efficacy of that initiative over the next cycle.

Yes. Sean, I'm not sure the term new is right, but certainly different commercial models. I remember back in the early 1980s when a lot of risk was from the driller, but a lot of rewards were from the drillers. They were value-based or performance-based contracts in 1980s. It's typically in these periods of really low commodity prices, when our customers get more creative, we get more creative with how to split up that value proposition and the risk proposition. The difficulty is I've never really seen any contractors win out long term on those battles. The one piece of discipline that's worked long term quite well is capital discipline and capital allocation. So our customers recognize that we build a new rig or do an upgrade, they have to pay for it. That's been enduring through multiple cycles, going back to 1980s, through 1990s, 2000s, now 2020. So I'm confident that we have to invest meaningful capital that we can do that with customer support. So that part works and works pretty well. Now these other models around performance, whether it's rig performance or oil price performance that triggers the day rate, generally, that changes the risk sharing between the drillers and the E&P companies. So I think fair to say, we do have contracts that are both oil price-based or performance-based right now. We also have turnkey and footage contracts. We've been through all of these models. There are various ways of splitting the risk up. We're stepping very carefully around anything that might be a permanent shift and making sure we're not taking on more risk in the process or managing that risk and trying to achieve the right types of rewards. So I don't know that the -- I don't believe that the day rate model is broken forever, and I'm not a believer that performance model is going to take over, but I do think some mix of both will be around for a while, and we'll be playing on both sides of this.

I think that's very fair. And you mentioned the opportunity for the need for upgraded rigs at some point in the future. Brings up an interesting topic, which we've put a lot of pen to paper recently around, what could normalized rig demand look like next cycle? Could we see -- I mentioned in another call on lower-spec rigs or say just not super spec and further upgrades. Just curious how you see that progression in terms of, again, not asking to make an oil price call about 5 years out or something like that. But more about as we go towards some kind of more normalized level of activity, do you see day rate progression looking comparable to what we experienced in '16 through '19? Do you see any fundamental differences that investors should be mindful of as we go from, say, low levels towards some kind of new level of normalized over the coming cycle?

Yes. There's a lot happening in that question, Sean. And so I'll break it up into 2 pieces. I think there's a technology change that's occurring right now. And we're getting close to the end of the technology change from SCR rigs to AC rigs. There's no question that AC rigs have better control, better drilling parameters, better ROP. They're more efficient. And when you lace on top of that a pad walking system and a high-pressure mud system to drill long resource of the wells. So I do believe most of the wells we drill in the future in North American land will be unconventional horizontal wells, either short or long horizontal, like 5,000- to 10,000- to 15,000-foot horizontals. So I think most of the demand will be for AC super-spec triples. I think that's pretty much followed through. If you look at the past, it takes about 15 years for a new technology to completely displace an old technology. And if you think back to when Precision started AC rigs in the early 2000s or HMP started AC rigs in the early 2000s, it's about that 15-year mark now. So I think the DC SCR rigs, while there are still a few rigs that will still be running, most of the market will be AC super-spec rigs. I think we're now 3 or 4 years into the digital controls and digital analytics transformation. It's going to take a few more years. But there's no question, if you're drilling the same well over and over the rig, we're going to transition to more and more wells being digitally enabled, not just digital controls on the top driving draw works, but digital controls in the entire drilling process, using analytics, using steering, using all the controls we can do digitally automation. So I think that's the next transformation that's occurring. This is a big boy's game. Whether you're writing your own code, as some drillers are, or you're partnering with large players like [indiscernible], like with NOV, and with Hitachi and SAP, you have to do this on lots of rigs. You can't do just one rig at a time. If you're doing it one rig at a time, it'll take a decade and a half to learn how to do it. That's why we started off with 30 rigs and have moved to 38 rigs for development purposes. The same thing our peers are doing multiple rigs. So I think it's a scale-based game where really the market's consolidated and you've got large public drillers who are going to operate in a very behaved, disciplined manner. So I do expect the next hole on rigs will be pad-style rigs. They are digitally enabled, likely coming from 1 of the top 3 or 4 or 5 drillers. They're all going to operate quite disciplined, that, by the way, own most of the high-spec rigs. So I think you'll see more disciplined rebound where likely the returns look a little better this time. We're certainly on par with the last couple of rebounds we've seen where shale drilling pulled the industry forward.

Right. So to some degree, maybe there's incrementally more shift towards the super spec. And ultimately, a lot of the capital deployed has already been in the past. I mean similar to comments around Canada. And so to some degree, there should be a better cash flow profile and the return profile should look better in that for x amount of demand that we saw last cycle. That would be...

Yes. Said another way, I would say that the rig count probably has to rise 500 rigs from today's level before the first new build gets talked about. And we're a long, long ways from a 500 rig rise to current activity levels.

That's right.

In fact, we could see our activity go from our current levels of low 20s in the U.S. and 10-ish in Canada. We could get up to 60 rigs, 70 rigs in the U.S., 60, 70 rigs in Canada, and do that pretty much pushing everything through the [ one on one ]. Very little G&A, very little variable cost to add. Just the rig crews and the rigs go back to work. So a lot of torque off these bottom levels right now. So even a modest increase in activity, if we went from 25 rigs to 35 rigs, most of that EBITDA flows through the bottom line and generates free cash flow. Just a small amount of maintenance capital on the rigs. So I think a lot of torque off today's levels for earnings power and free cash flow.

I think that makes a lot of sense. So with the time we have left, I didn't want to spend a little time on international as well. You've had really good success in the Middle East. You built this business from the ground up. In some ways, that is the best market to be in outside of the U.S., but it's also one that's had started really increasing competition. How do you think about long-term value creation in your international rig fleet? Is there -- does it require share gains in order to further enhance the opportunity set there? Well, how do you think about long-term value creation for that international fleet?

Sean, I'm not even sure how to think about the term long term these days. But what I'd say is that we have -- right now, we have 3 new build rigs that are either just wrapping up their current contracts and due for renewal. So we could add 3 more rigs with no overhead, no fixed cost. We have the infrastructure in place. We also have 4 other idle rigs in the region right now. So we could double our activity with essentially no capital. So that doubling of activity could be a 2- to 3-year cycle for us. So if you call that long term right now, I don't see much capital. But I do see room to kind of respond to customer demands in Kuwait, Saudi and other Arabian Gulf region countries, probably Iraq, Kurdistan, maybe Bahrain or Abu Dhabi or Oman and those areas, minimal rate cost. But I think we can essentially double our activity right now without a lot of capital. So that's how I'm looking at that market for the near term, next 2 to 3 years.

Sure. That's fair. And so then as we're kind of wrapping up here, as you think about the U.S. and Canadian markets over the coming cycle, it seems like cash flow is going to be a priority. You've done really well, better than most in terms of those with levered balance sheets, making meaningful headway towards reducing interest expense and bringing down those debt levels. Do you see -- if we have to look at the intermediate to long term, do you see potential for where the capital allocation decisions shift? And what could that look like on a long-term basis for Precision?

Yes. So I'd say that we're staying on track for the near term, next 2 to 3 years, for our long-term debt reduction targets. That we really want to get our total leverage levels down to kind of 2x mid-cycle EBITDA. So we probably have -- I think our current targets probably remain appropriate. I can see that we're going to achieve those in a constrained environment. We've got a good cash flow profile right now. It doesn't take a lot of rigs for us to generate free cash flow. So getting -- spending the next 2 to 3 years blocking and tackling, getting debt levels down near priority. I think with the asset base we have right now and even a modest increase in business, we'll be generating a lot more free cash flow. As I said, most of any additional rigs flow straight through. We could easily be in a capital return mode inside the next 3 to 4 years where we're returning capital directly through dividends, through share buybacks, through other methods. I mean we did buy back a good portion of our shares, I think, around 6% or 7% late last year, early this year. We paused that through a period of uncertainty, but we're starting that again. It wouldn't be off the agenda even in the next -- inside the next 3 years.

Got it. Well, that's great. We're about out of time. So Kevin, just once again, on behalf of JPMorgan, I want to thank you for joining us virtually here today. It's really great. As always, enjoy spending time with you. So thanks for doing it today. And to everyone else here, have a great conference. Thanks for joining us.

Great. Sean, thank you. Hopefully, we can meet in New York next year. I hope things calm down there. Thank you.

Sounds great. Thank you.

Bye, bye.