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Morningstar | Patterson's First-Quarter Results Marred by Pressure Pumping Industry Onslaught

Patterson's results fell sequentially, with revenue down 12% and adjusted operating margin slipped to negative 4.5% from negative 1% previously. The drop is due mostly to the Pressure Pumping segment, where revenue fell 23% sequentially and adjusted operating margin fell to negative 8% from 0% previously (the segment's worst in two years). For now, our fair value estimate and no-moat rating are unchanged.

Patterson's pressure pumping weakness was due to industry headwinds. As a reminder, U.S. shale well completions have fallen in past quarters due chiefly to temporary pipeline bottlenecks in the Permian Basin. Cumulatively, the U.S. horizontal well completions count fell by about 18% from the third quarter of 2018 to the first quarter of 2019. Over the same time period, Patterson's pressure pumping revenue have fallen by 41%, due to about a 21% decrease in fleets deployed plus a 25% decrease in revenue per fleet. This severe fall in revenue per fleet reflects largely weaker pricing.

We expect U.S. shale completions to recover in the second half of 2019 as new pipelines come online, which will allow Patterson's activity levels to recover. On the other hand, a full pricing recovery will elude Patterson, in our view, as industry pricing was excessive in the first half of 2018 and due to fall. However, we think Patterson does have some room to improve its profitability by catching up in its efficiency to industry leaders. Indeed, the company improved its efficiency markedly in recent quarters, with the average stage count per fleet increasing 5% in the first quarter.

In Patterson's other main segment, Contract Drilling, revenue fell 4% sequentially owing to a 4% lower rig count. However, operating margins were basically flat owing to a bump in gross margins per rig day to $9,700 from $9,400 previously.

U.S. land drillers had a great first quarter overall. Although the U.S. horizontal rig count fell by 2% sequentially, Tier 1 rig utilization remained fairly strong (at about 80%-85%), with "super spec" rig utilization well above 90%. Tight utilization allowed for land drillers to continue to push pricing increases, and as a result gross margins per day for the driller increased 11% on average (to $10,400 per day from $9,400).

Unfortunately for U.S. land drillers, we forecast that the U.S. horizontal rig count will fall from almost 900 today to about 700 by 2023 as U.S. shale drilling moderates and drilling efficiencies continue to improve. This means that utilization and hence pricing will fall in coming years (even for super spec rigs), pushing down drillers' financial results. This doesn't appear to be fully grasped by the market currently, and Patterson is trading over 40% above our fair value estimate.