I assign a Neutral rating to oilfield services company Weatherford International (OTCPK:WFTLF).
The risk of bankruptcy for Weatherford has been substantially reduced with $500 million in fresh capital raised from the issuance of new senior secured first lien notes, although its gearing remains high. Also, Weatherford is expected to deliver annualized cost savings in excess of $800 million this year, but it needs to strike a delicate balance between cost savings and maintaining market share.
A significant improvement in the company’s free cash flow, larger-than-expected structural cost savings, and market share gains in key product segments and market are the key re-rating catalysts that could prompt me to change my rating on the stock to Bullish.
Weatherford refers to itself as a “leading wellbore and production solution company providing equipment and services used in the drilling, evaluation, completion, production and intervention of oil and natural gas wells” in the company’s FY 2019 annual report. The company has around 18,000 employees working in more than 80 countries globally.
An Overview Of Weatherford’s Products And Services
Source: Weatherford’s FY 2019 Annual Report
Weatherford reports the company’s financial results by geographic segment, namely the Western Hemisphere and Eastern Hemisphere. The company generated 43% and 57% of its 9M 2020 revenue from the Western Hemisphere and Eastern Hemisphere segments, respectively. With respect to earnings contribution, Weatherford derived three-quarters of its 9M 2020 EBITDA from the Eastern Hemisphere segment, with the remaining 25% of revenue contributed by the Western Hemisphere segment.
The Definition Of The Western Hemisphere and Eastern Hemisphere Segments
Source: Weatherford’s FY 2019 Annual Report
A More Detailed Revenue Break-down Within The Western Hemisphere and Eastern Hemisphere Segments
Source: Weatherford’s 3Q 2020 Financial Results Presentation Slides
Improvement In Liquidity Reduces Bankruptcy Risk Substantially
In the earlier part of the year, Weatherford was at risk of being bankrupt again, after emerging from Chapter 11 bankruptcy protection at the end of 2019. But Weatherford’s liquidity has improved substantially in the past few months.
The company’s cash balance increased by +$537 million QoQ to $1,293 million as of September 30, 2020. This was primarily driven by fresh capital raised in August 2020 from the issuance of senior secured first lien notes which amounted to $500 million, and positive free cash flow of $105 million generated in 3Q 2020. The new notes issued have a coupon rate of 8.75% and mature on September 1, 2024.
Utilizing the proceeds from the new senior secured first lien notes, Weatherford refinanced its senior secured asset-based lending agreement. As a result, the company was no longer at risk of breaching debt covenants associated with the senior secured asset-based lending agreement, and it does not have any debt maturing till the second quarter of 2024. In addition, Weatherford also negotiated successfully for a decrease in the minimum liquidity covenant for its senior secured letter of credit agreement.
At the company’s 2Q 2020 earnings call on August 5, 2020, Weatherford stressed that the issuance of senior secured first lien notes “replaces the ABL credit facility (senior secured asset-based lending agreement) and eliminates the risk of non-compliance (breach of debt covenants)” and “provides a liquidity runway for the company to meet its obligations and continue to address the challenges of this market.” More importantly, Weatherford ruled out the possibility of further capital raising, noting that “at this time that we don’t need to raise more capital” as the $500 million in fresh capital “affords us the full right to manage our business with liquidity on hand.”
In a nutshell, the risk of bankruptcy for Weatherford has been substantially reduced, due to the significant improvement in the company’s liquidity as highlighted above. Earlier, the company could have potentially breached its debt covenants and be forced into bankruptcy, as it did not have the liquidity and financial health to survive in a challenging operating environment brought about by Covid-19 and the oil price crash.
However, Weatherford’s gearing remains high, with estimated gross debt-to-equity and net debt-to-equity ratios of 255% and 156%, respectively, as of September 30, 2020.
New CEO Appointment Draws Attention
It is noteworthy that Weatherford has got a new captain to be in charge of the ship in such turbulent times. On September 10, 2020, Weatherford announced that Mr. Girish K. Saligram, formerly Chief Operating Officer at Exterran Corporation (EXTN), will be appointed as the new President and Chief Executive Officer of the company with effect from October 12, 2020. Former CEO left Weatherford on June 7, 2020, and the company did not explain the reasons for his departure.
As with any new CEO appointment, there are fears that there could be a significant change in the company’s strategic direction, which might not be necessarily positive. Weatherford’s Chief Operating Officer Karl Blanchard, who was also the company’s interim CEO after Mark A. McCollum left, addressed this issue by highlighting earlier at the company’s 2Q 2020 results briefing in August 2020 that “we aren’t changing strategy” despite changes to the management team, and the company is “intensifying our cost management as we go into this market environment.”
Weatherford’s focus on cost management is necessary for the company to remain solvent in the current challenging environment, but it could come at the expense of potential market share loss as detailed in the next section of this article.
Striking A Delicate Balance Between Cost Savings And Maintaining Market Share
Weatherford disclosed in its 3Q 2020 results presentation slides that the company expects its cost management initiatives to deliver annualized cost savings in excess of $800 million this year, and guided that “further cost and efficiency improvements expected going forward.” But it is important to note that about half of these cost savings are derived from lower activity due to Covid-19 disruptions, while the other half is structural in nature and more likely to be permanent.
Given that a significant part of the cost savings relates to closure of facilities and the exit from certain markets, there are concerns that Weatherford could be sacrificing its market share to cut costs.
Weatherford addressed such concerns by noting at the company’s 2Q 2020 earnings call on August 5, 2020, that “we have held share and in fact, in some cases, have been gaining share in certain product lines over the last few quarters.” The company has maintained or even increased its market share in various segments despite cost-cutting efforts, due to two key reasons.
One key factor is that Weatherford is exiting markets which are not significant contributors to the company’s top line. The other key factor is that the company is not necessarily completely exiting some of the other markets. Instead, Weatherford has optimized its products and services offering in certain markets, and focused its efforts on segments of specific markets with a higher level of activity and greater demand.
Valuation And Risk Factors
Weatherford trades at 6.1 times consensus forward next twelve months’ EV/EBITDA based on its share price of $3.75 as of November 30, 2020.
The key risk factors for Weatherford include a deterioration in the company’s liquidity and free cash flow, a potential change in the company’s strategic direction under the leadership of a new CEO that possibly destroys value, and market share losses in the company’s key markets and product segments.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.