Patterson-UTI Energy, Inc. (PTEN) Earnings Call Transcript & Summary

All right. Good morning, everyone, and thank you for joining us for this oil services panel on the outlook of activity and pricing in U.S. land services. We've got John Lindsay, CEO of Helmerich & Payne; Chris Wright, CEO at Liberty; Robert Drummond, CEO at NexTier Oilfield Services; and Andy Hendricks, CEO at Patterson-UTI. Thank you for taking the time to talk to us.

John, I'd like to start with you. H&P is up 80% in 2022 over the last 12 months. But really, everyone, NexTier is up 118%; Liberty is up 40%; Patterson, 72%. 2022 has been a rate of change story. But how do you think about 2023? First of all, how is 4Q looking? And Andy, I know you had a press release, so would allow for you to talk about it. What should investors expect from 2023? And what are you most focused on? John, maybe you start.

Well, again, thank you for having us. Yes, 2022 was a great year, particularly when you contrast with what we've been through the last couple of years. But 2023 looks really positive. Our fiscal year end is September 30, so we just finished our first quarter. And things look really well. In terms of our focus, we're going to continue to spend a lot of time focusing on our customers or in the customer service business, focusing on customers, delivering better outcomes, utilizing the best technologies possible. We're going to focus there. Obviously, spend a lot of time focusing on growing margins. We talked back in February that since 2014, we hadn't seen 50% gross margins since that time period. And so our focus is getting back to that 50% gross margin. We're really looking at other ways to return capital to shareholders. We announced our supplemental dividend back in October. So that's another focus for us is figuring out how to get more back to shareholders. And then finally, just international growth. We see that as a great opportunity. We think going to continue to be more unconventional drilling internationally, and we think we're going to be in a position to take advantage of that.

Andy?

Listen, I'm really excited about the macro for 2023. And when you look back at what's happened since we've come out of this downturn over 2020, activity has ramped up, pricing has ramped up even at a much faster pace than activity has. But this cycle is different. And I know everybody talks about it, but it really is different than the cycles we've seen over the last decade. Our customers are growing activity, but not at the same pace they did in the past. So they're not likely to overproduce the global needs for oil and gas that they have in the past. And so this cycle has the potential to have much longer legs than any previous cycle we've had. And that difference is allowing us to continue to increase our average pricing throughout '23, and that's why I'm really upbeat about this year. Even if we don't put out another rig, which we are, or even if leading-edge day rates for services don't go up, which I think they still do, our average rates are still going to continue to move up quarter-on-quarter as we reprice contracts and agreements that we signed in '22. And so I'm still upbeat for '23 and the overall macro. I still think it's an exciting time, whether you're a drilling contractor or you're in services, this is still a really good year.

And for NexTier, we really are coming off a really exciting 2022, but we do also believe in really strong macro. We've been focusing a lot on return on invested capital, and it's showing up in our numbers as we exit Q3. And we are in a position to expect profitability to improve substantially in 2023 without very much investment in growth CapEx. We did a bit of countercyclical investing to move our fleet more and more towards natural gas as a power source for many reasons, including the fuel arbitrage between diesel fuel and natural gas, and we're going to continue along that path as we go through 2023. But at any points out, the discipline that's been established by our customer base is rolling into the plans, I think, of our host sector. And our host sector is really -- I'm talking about frac mostly, is really improving in ROIC in general. And I think our messaging to the investors need to be a little bit more focused on that, maybe in less on EBITDA growth that we've kind of measured ourselves with in the past, kind of symbolic to the E&P is being measured for production growth. But we're in a great position going into 2023 and very excited about the opportunities.

Yes. I think may be familiar, but we're in a great setting for the macro right now. Business conditions are very strong in our industry. We've got relatively tight global oil supply and demand markets. Maybe some issues with the ability to move natural gas, but they'll be solved in the next year or 2. So business conditions outlook is very multiyear technology investments that are coming to fruition right now, maybe most publicly with our digiFrac solution, which I think is going to be game-changing. We've got some great new software coming out of logistics, handling wet sand, some innovative ideas that are being strongly embraced by customers. We've had a tougher tighter market where operational quality, I think, has become huge for customers. There are people that are struggling and there are people that are killing it and delivering well. So yes, pretty happy where I am right now and happy New Year to the crowd.

Great. John, you mentioned about 40 to 50 rigs being added throughout 2023, and Andy, you've spoken about 100. So maybe can you talk about the thought processes there? How do you get to those numbers? And in terms of the customer conversations, what are the private saying? What are the major thing? And how do you think about the mix between the players?

Yes, that 40 to 50 number now is dated a little bit. But again, we're excited about the opportunity. Things are looking good. I think -- and when I'm looking at it now, it seems like that would be on the higher end of the spectrum, which again, I think is really a good thing. I think that would really be a good thing is for the industry to focus less on adding additional units and more on focusing -- in our case, growing margins. As the data points, when you're trying to figure out what the supply-demand curve is, a lot of what we try to look at is demand points coming from customers that are at least a year rather than looking at it on a shorter-term basis. And so we've been able to satisfy most of our customer demand churn from our own rigs are being released for various reasons. And so that's worked out really well for us. So it's really hard to predict what the number is, but I think the total adds for 2023 are going to be on the lower end of the spectrum, which again, I think is healthy. It's been mentioned, it's having capital discipline, much like our customers are just like the E&Ps are.

What about the conversations with the private -- between the privates and the major...

There's no doubt that the privates carried a lot of the increases in 2021 and through '22. We've had most -- a lot of rigs have been going to work for the larger public players, including majors. I think it's going to continue to be that way. We have seen a little bit of softness on the privates. But typically, what happens is a private releases a rig, and it gets picked up by another private company. There's a lot of interest in rigs. A customer would much rather have a rig that's been active than pulling a rig out of stack.

Got it. Andy?

So we were serving customers back in September. And of course, WTI was above $80 a barrel back then and the number we came up with for 2023 was an industry rig count of an increase of around 50 rigs. Now with oil trading plus or minus $75, I think that moderates a bit same as what John is explaining. I think that does come down, but I don't think that affects any of us either. I'll talk about what's happening within the rig count, but there's different classes of rigs in the overall rig count. You've got mechanicals and SCRs, which make up over 100 of those rigs in the rig count, and then you've got AC and super-spec rigs. Certainly, over the last few months, a lot of discussion about privates dropping rigs, and rig count with privates, but they were mechanical rigs. They don't affect -- and the market for the AC, super-spec rigs still remains tight, and that's still a very tight, disciplined market and it will be throughout '23.

And you mentioned leading-edge day rates and the trajectory of the overall margins for your business. How do you think about the cost trajectory? The -- as you think about contracts rolling over, where do you think you will land for 2023 on average? Where do you exit? And is there an incentivization for longer-term duration contracts now in the market? Or are you still looking for shorter-term durations where you can benefit from the churn later on?

So what we said at the last earnings call, and I believe it still holds true today, is that leading-edge day rates with everything all-in, for super-spec rig, with your drill pipe, with extra people, any kind of rental equipment that we provide is running around $40,000 per day. Now interestingly enough, our costs have gone up, too. So our margins are still not back to peak margins either. So there's -- we still think there's upside on the margins because of that. But today, even though that's leading-edge, that's not our average. We're working rigs today that we sign contracts on a year ago that were around that $20,000 a day range. But that's what's going to happen and reprice in '23. As these contracts roll in '23, all of a sudden, it's a step up for some of these rigs at that $20,000 level all the way up to leading-edge. And so that's what you're going to see in our financials through '23. And that's what we're excited and upbeat about. It's the fact that we're going to have a longer duration up cycle that gives us more time to mark to market and raise our pricing up towards leading-edge.

John?

Yes. I agree with that. And on the term contract, we had 60 rigs over the last couple of quarters that rolled off or were rolling off. And after those rolled off in our fiscal Q1, and we'll have another half roll off. Some of those are going back into term. Some are going to go into the spot, but they're all going up dramatically more towards leading-edge pricing. And so we would expect that. I think in general, it's been -- over time, we've had about 50% to 60% of our fleet that's under term contract. I think that's good management on those term contracts. So I think there's a lot of upside ahead. Again, I think just the capital discipline that everyone is showing is really important to this longer cycle that we're discussing.

I'll turn it to you, Chris and Robert. On -- in terms of the profitability per fleet and what the trajectory looks like for 2023, how are you thinking about it? How should investors underwrite maybe the entry and the exit rate for '23? And then on the back of that, do you see any appetite for net additions in the market? I know you've mentioned your own company's plans, but as you look at your competitors in the market, the private players, is there any appetite that you have a net addition at the end of '23?

Thank you for the question. And just a quick reflect back on the rig count projections. I would say not surprised that it's coming down just a bit simply because of the fact that we believe that the bottleneck for U.S. land growth and production is the frac fleet is fully sold out. And the supply chain for us to be able to expand that [indiscernible] we're building on it and '23 is very good, which sets up -- we see 2023 profitability to significantly improve over 2022. And one of the big factors there is contract terms as it relates to pricing as well as other terms associated with how do you manage downtime, how do you manage minimum hours for a frac fleet, things that are very important to keeping that factory working day in and day out. To your question is about where we see that going. We're more and more focused on pricing and measuring the returns on a per pump basis or per horsepower basis. So the number of fleets might vary quarter-to-quarter depending on how you configure them and what geographical region that you place them in. But when you look at it on an average, we would expect to see that number in the low-30s in 2023. There are some companies already demonstrating that in the most recent quarters in our sector. And I think that more and more looking at EBITDA per fleet as a measure may not be the best way to do it simply because there's so much variation in size of fleet geographically and in what is included in each of our company's strategies. So more and more, I think the messaging from us is going to be around focusing on return on capital and driving that through how we manage our cash and our investments and our profitability. As it relates to M&A and the need for more of it, I mean, there's been a significant amount that have occurred from all of us and the public side of that sector -- this sector pretty well. And I think we all benefit from each one of those moves. There's a transition occurring in the fleet today, moving away from diesel towards natural gas and much cleaner fuel, but also benefits from the arbitrage between diesel prices and natural gas prices that are even getting better in '23 versus '22. So there's a significant return on investment for making those investments without adding additional capacity to the overall fleet. So I think when you look at us for managing our market share in a range of flat between 12% and 14%, we would have an eye to looking for M&A opportunities. But we don't really see a lot of those that move the strategy of moving from diesel to natural gas very quickly. But we do see numerous opportunities for M&A around our fleet that is part of our well site integration strategy, things that help us control our own destiny like last mile logistics or other fueling options that build around our Power Solutions business. But the opportunities for 2023, in general, I believe the macro is set up just as good as it was in 2022 versus 2021.

Yes, I think that, as you said, the market conditions are strong. Really only one thing we look at or care about, and that is our return on capital invested, cash return on cash invested. I've been a private company guy most of my career, now a public company. We're 11 years old. We've had 23% cash return on cash invested from the day we founded the company to today. So that's what we look at. And that's about 50% higher than the S&P 500 and of course, far higher than our industry. And that's not been fat years for the industry, right? Those have been 10 tougher years. Now we're going into better macro conditions, we would expect returns to elevate. And so that's how we look at it. If we're going to an acquisition or an investment in technology or deployment, it's all about that return on capital employed. But we are in a position right now. We have an internal frac fleet count. We know every active frac fleet in the country, and we talk to everyone who's running an active frac fleet to hear their plans. And so people's plans sort of factor in another 15 or 20 fleets from where we are now to sort of mid- to the -- maybe the second, third of this year. That's tough. That's tough as far as where those fleets will come from. But that little incremental pull is what keeps the macro conditions strong. We grew capacity a bit last year. For us, it's all -- we look at it on a micro level, it's customer relationships, a particular opportunity, how do we evaluate that, what we're going to do. So we look at sort of -- obviously, we're generating meaningful free cash flow right now. And if things roll as they are, obviously, that will be a lot larger. And then it's what to do with that. We reinitiated our share buyback program in Q3. We bought 2.5% of our total shares outstanding in our first quarter of the buyback program. We bought our dividend back but pretty compelling opportunity in buying our own stock at sort of nutty valuations right now. So that's a negative at 1 level, but it's an opportunity at another.

I'll come back to that in just a minute. But Andy, did you want to jump into the pressure pumping comment?

Sure. So we operate 12 frac spreads, 7 of those are primarily natural gas fuels or dual fuel systems. Our team is doing a great job. Really proud of the progress that they've made over the last few years and the returns that we're getting out of that business. One thing that's changed for us over the last 4 months is that we're seeing an increase in demand of horsepower per spread. We've got customers that want to pump higher rates and higher pressures. And so while we had been talking about potentially putting out and hadn't made a final decision. That decision could be delayed just because of the fact that we've been consuming horsepower on the existing jobs that we're at. And I think that's part of what you're seeing in this overall tightness in the market. There may be some new equipment coming out there. But across the industry, it may not just be specific to us. It may be others as well that are increasing the horsepower per spread, and that's what's keeping this market tight on top of everything else.

Chris, I'll come to you. You were talking about the capital return strategy. And Chris and Robert, but you have slightly different approaches to the whole thing. Can you talk about the philosophies behind that. Why do you prefer one strategy for your company whereas investors might be asking for a more defined program? How do you think about that narrative?

Just the opportunities are more variable. Yes, we've never been a fan of the total formulaic, X percent will go here or go there. Key for us, the long-term goal maximize the value of the share, right? And you do that by having high returns on cash invested and then some combination of reinvesting to grow your competitive addition grow your ability to increase profitability per share, and then direct returns to shareholders through dividends and repurchases. And repurchases for us is very much a factor of what's the gap between some conservative estimate of intrinsic value and the value at which you can buy a share. These are not precise numbers by any, but that gap is enormous. The appeal of buying back shares is tremendous. Now in today's world and from the platform we sit on, we also have tremendous investment opportunities in our own business, not necessarily adding new fleets, but a higher spec fleet that customers really want or other enabling technologies that make our fleet more efficient or grab a larger percent of the spend in the whole frac completion world. So yes, for us, it's how do we maximize the value of a share. And so obviously, returns to shareholders will be a large piece of that, but it's not formulaic for us.

Slightly different maybe for us only in the sense that we feel like we're -- our sector in general, pretty extremely undervalued, considered the earnings potential Chris pointed out, and I pointed out a little bit. And trying to tell the investor base how we're going to behave, we believe putting a little structure around our capital allocation, in general, might help accelerate people coming back to our sector. It seems to have worked in some cases for the E&Ps. And at this point, we did in our last earnings call, coming out with a little guidance about what we would do with the earnings and the free cash flow that we're generating, which has been really substantial. And it does have flexibility built in it, but it is structured as well. We've said that we would get to net debt 0 in 2023. We said that we were going to invest in our fleet to keep the fleet as strong as it was at the end of the year as it began the year while simultaneously slowly transitioning it from diesel to more and more natural gas, as well as kind of managing our market share flat with whatever the market conditions do. And I think the third thing that we allocated to was committing to 50% of our free cash flow to be returned to our shareholders. And the fourth being -- and we can fund all 4 of these buckets, if you will, would be on flexibility around building some cash balance on the balance sheet to help us with M&A opportunities, as I mentioned, most likely around our integrated strategy. And if we don't find anything attractive, it could also be put in the capital return process. So yes, it's a bit structured, but it's driven to try to make our investors see that how we're going to behave in the future and that we're going to take care of this earnings potential situation that we're in today.

Staying on that theme, I think one of the common questions we get from investors is, how do I own this for a return of capital strategy, whereas the stocks have tended to behave on a quarter-to-quarter basis because everyone's been buying the stocks for an estimate revision cycle, that requires a shift in mentality to a certain extent for pressure pumping in particular, how do you think that, that occurs? Do you think that's a duration game? Is there more visibility into pressure pumping profitability or free cash flow over a multiyear period? How do you think that plays out?

Look, our industry beat up because it's cyclical. And so therefore, we don't like it as much. I absolutely disagree with that, call me strange. When an industry is cyclical, any industry where you build an asset that lasts a long time is cyclical, commercial real estate, our industry. And to us, cyclicality brings another lever that makes the business difficult and therefore, a better opportunity to grow competitive advantage, a wider range of outcomes of the competitors in the business. I think it was Warren Buffett who said he would take a lumpy 12% return over a smooth 10% return any day. We agree entirely. We're in this business because of the opportunity for high returns on capital. And again, Buffett taking a 12% lumpy return, we've been at 23% return in a rough 10 or 11 years for our industry. So if you have strong returns on the cash you invest, your optionality to accrete shareholder value through growth, through dividends, through buybacks, they're simply tremendous. So for us, we hope a broader investor base recognizes the superiority of a business with strong returns on capital throughout the cycle. And of course, we've all been harmed by sort of a naive politically driven view that soon, we're not going to be running on oil and gas, nothing in the map, nothing in the numbers supports that. In fact, if you look at oil demand growth, 1.1% compounded annual growth rate in the '90s, 1.1% in the 2000 to 2010, 1.2% in the last decade pre-COVID. So look, our industry is the dominant source of powering the world. It was when I was born, and it will be when I die. Now if there's a lack of appreciation that today among investors, which there is, that will change.