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Morningstar | Land Drillers See Improved 2Q Results, But Our Bearish Thesis Is Still in Place

Unsurprisingly, land drillers Helmerich & Payne, Patterson, and Precision all posted solid improvement in their second-quarter results, owing to increases in U.S. shale activity levels. Our fair value estimates and no-moat ratings for the companies are unchanged.

Rig counts for the three companies improved an average 6%, buoyed by an 11% increase in the overall U.S. horizontal rig count. Overall Tier 1 rig utilization has reached about 83% by our estimates--the highest mark since the fourth quarter of 2014. Despite tightening supply, pricing increases have remained lackluster, with average gross margin per day increasing just 4% sequentially to about $8,000 per rig day for our covered companies, below our long-term expectation of about $10,000 per day.

Nevertheless, companies did give solid indication that the persistence of rig utilization at current levels would eventually lead to much improved pricing. Indeed, Helmerich & Payne noted that it had signed seven new contracts for 2019 at an average gross margin per day of $11,500, above our long-term estimate of just over $10,000 per day for the company (although we note still below the market-implied expectation of at least $13,000).

Unfortunately for the drillers, we think it is highly unrealistic to expect rig utilization to remain at current levels. We expect the U.S. horizontal rig count to fall from about 930 currently to around 700 by midcycle, driven by both a need for U.S. shale oil production growth to moderate to more sustainable levels, as well as increased drilling efficiencies which reduce the number of rigs required to fulfill U.S. shale activity needs.

Although their share prices have fallen in the lasts two months, we think the market still overrates the drillers’ ability to sustain higher utilization levels and achieve higher pricing. The average land driller looks about 30% overvalued.