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Morningstar | Land Drillers Patterson and Precision See Improvement on Higher U.S. Rig Count

Land drillers Patterson and Precision posted solid third quarters, with both companies’ U.S. land drilling businesses benefiting from a 5% sequential improvement in the U.S. horizontal rig count. Patterson’s contract drilling segment saw a 4% increase in revenue owing to a 3% increase in the company’s rig count and a slight bump in day rates. Precision’s U.S. drilling business saw a 5% increase in revenue owing to a 6% increase in rig count but slightly slipping day rates. Precision’s Canadian drilling business saw its usual sharp seasonal uptick for the quarter, but revenue was also up 5% versus the prior-year quarter. Our fair value estimates for both companies and no-moat ratings remain in place.

Management from both companies noted that leading edge day rates are very strong--perhaps 10% above current fleet averages for the companies. We agree that if current rig demand remained in place, the pricing outlook would appear quite rosy for the drillers. Unfortunately for the drillers, we think we think rig demand is headed downward. We forecast that the U.S. horizontal rig count will fall from about 920 in the third quarter of this year to about 650 by 2022, driven by reduced shale drilling activity as well as drilling efficiency gains.

Outside of the drilling, Patterson saw pressure pumping revenue decrease 1% as the company parked about 16% of its pressure pumping capacity owing to adverse market dynamics--operators’ demand for pressure pumping is temporarily waning owing to Permian Basin takeaway constraints. This issue should be alleviated by mid-2019, after which demand for pressure pumping will rebound, although we don’t think pricing will resume the upward trend seen from 2017 through early 2018 owing to fierce competition in the industry. We were impressed that Patterson’s pressure pumping segment adjusted operating margins for the third quarter only slipped to 4% from 5% despite the headwinds.

Precision’s pending acquisition of Trinidad Drilling doesn’t materially alter our view on the company, for now. We value Trinidad assuming a midcycle rig count of 54 (slightly below 2018 levels owing to lower U.S. activity) as well as an enterprise value of $8.5 million per operating rig (slightly below Precision’s $10 million per rig owing to lower margins stemming from lower rig quality). Under the deal terms, this results in a negligible impact to our fair value estimate for Precision.