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Credit market woes compounding risk in oilfield services sector, analysts say

Despite healthy balance sheets for many across the oil and gas equipment and services sector, a few companies have an elevated risk of defaulting as investors flee the sector, according to analysts.

The oilfield services sector faces a host of concerns, most pressing is that many oil and gas producers are shifting from a high-spending, growth-oriented model to one of capital discipline, Barclays lead analyst J. David Anderson said in a May 20 note. Other issues include a modernization of some businesses, separating product divisions from services divisions.

Oil and gas price volatility is creating an uncertain outlook for onshore oilfield activity that is also driving investors away from oilfield services stocks, Tudor Pickering Holt & Co. analyst Byron Pope said in a May 23 sector update.

Compounded by the May 13 announcement from Weatherford International PLC that it will seek bankruptcy through Chapter 11, "it is hard for folks to get excited about owning [oilfield services] stocks over the near term," Pope said.

Struggling to emerge from the 2014 downturn, the oilfield services sector is undergoing "capital structure restructuring," Pope said. In line with customers' focus on spending within free cash flow with investor returns in mind, oilfield services companies are adjusting spending, investing only where needed and waiting for firm commitments before adding new inventory in an oversupplied market.

Despite their efforts, "it feels like the recently announced (and high-profile) capital structure restructuring situation in the [oilfield services] space has caused investors to indiscriminately shoot (OFS stocks) first and ask questions later," Pope said.

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On the heels of Weatherford's announcement there are several oilfield services companies that could be in the cross-hairs next as credit market worries compound concerns already present in the equity markets, leading to dramatic underperformance, Anderson said.

The North America land market makes up 64% of Houston-based oilfield services company Superior Energy Services Inc.'s 2019 estimated revenue. As a result, a lack of "high-quality, differentiated" and common businesses within the market leaves the company vulnerable, the Barclays analyst said.

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Proppant provider Hi-Crush Partners LP benefited from strong volumes and margins due to its early entry into the Permian in-basin sand market, but those advantages have abated, driving a shift in the company's focus to building out its last-mile logistics offering, which focuses the final steps of the delivery process. The risk for Hi-Crush is that the last-mile logistics market is going to become saturated due to low barriers to entry and a vast offering of solutions, Anderson said.

An improving market with a growing list of green shoots provides promise for offshore drillers, but Barclays sees challenges for London-based drillers Noble Corp. plc and Ensco Rowan PLC.

A big risk for Noble Corp., according to Barclays, is that the driller may have to pay an estimated $170 million to settle a lawsuit that claims it jettisoned a fleet of old offshore drilling rigs in a 2014 corporate spin-off called Paragon Offshore PLC. The spin-off filed for Chapter 11 bankruptcy in February 2016 and re-emerged in July 2017. Noble also has about $2.2 billion of maturities due through 2026, the analysts highlighted.

While Ensco Rowan has $1.57 billion of cash and short-term investments on hand, Barclays does not see positive free cash flow for the company in either 2019 or 2020, as it faces a "wall" of maturities from 2024-2026 totaling about $4.16 billion, which is "daunting," Anderson said. Ensco Rowan was formed when two formal rivals Ensco PLC and Rowan Cos. PLC combined in a merger of equals. The deal closed in April.

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But most oilfield services subsectors, and the companies operating within them, will generate mid-single digit free cash flow this year, Pope said.

Coupled with generally healthy balance sheets and lots of availability under their credit facilities, oilfield services companies should not be painted with a "broad brush," Pope said. Oilfield equipment and product suppliers remain healthy bets even if a selloff in oilfield services stocks continues, Pope said.

Tudor Pickering Holt said stocks worth owning include: Texas-based pump and equipment provider Apergy Corp., which it prefers due to its artificial lift space; Houston-based Baker Hughes, a GE company, as it is "beautifully positioned" for LNG market growth; Houston-based equipment provider Cactus Inc. for its wellhead and pressure control equipment solutions; Netherlands-based service provider Core Laboratories NV, due to their niche reservoir rocks/fluids-centric portfolio; and Houston-based service company National Energy Services Reunited Corp., with its "beautiful [Middle East and North Africa]-region growth story."

For those companies identified at risk there are hopes for recovery, the analysts said. Drillers and sand providers should use free cash flow to pay down debt, Pope said.

With limited opportunity in the U.S. land market, Superior Energy has shifted its focus to offshore and international markets. Anderson said Gulf of Mexico activity needs to recover for Superior Energy Services to make the most of its "market-leading" drill pipe business that, despite making up only a small part of its portfolio mix, has the ability to generate significant free cash flow. In order for the company to reverse the performance outlook, international growth must also continue, Anderson said.

For proppant-provider Hi-Crush, the investments and acquisitions made in last-mile logistics need to prove to be differentiated solutions that add value for operators by reducing or eliminating nonproductive time, he said.

For the offshore drillers, the market recovery needs to take place quickly so that Ensco Rowan can generate the significant free cash flow it needs to absorb its excess capacity and increase day rates, Anderson said.