Precision Drilling Corporation (NYSE:PDS) Q1 2024 Earnings Call Transcript

Precision Drilling Corporation (NYSE:PDS) Q1 2024 Earnings Call Transcript April 25, 2024

Precision Drilling Corporation misses on earnings expectations. Reported EPS is $1.88 EPS, expectations were $2. Precision Drilling Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and thank you for standing by. Welcome to the Precision Drilling Corporation 2024 First Quarter Conference Call. I would now like to hand the conference over to Lavonne Zdunich, Vice President, Investor Relations. Please go ahead.

Lavonne Zdunich: Thank you, operator, and welcome, everyone, to our first quarter conference call. Today, I am joined by Kevin Neveu, Precision’s President and CEO; and Carey Ford, our CFO. Earlier today, we reported our first quarter results. To begin our call today, Carey will review these results and then Kevin will provide an operational update and outlook commentary. Once we have finished our prepared comments, we will open the call for questions. Please note that some comments today will refer to non-IFRS financial measures and include forward-looking statements, which are subject to a number of risks and uncertainties. For more information on financial measures, forward-looking statements and risk factors please refer to our news release and other regulatory filings available on SEDAR and EDGAR. As a reminder, we express our financial results in Canadian dollars, unless otherwise stated. With that, I will turn it over to Carey.

Carey Ford: Thanks, Lavonne. Precision’s Q1 financial results exceeded our expectations for adjusted EBITDA, earnings and cash flow. Adjusted EBITDA of $143 million was driven by strong drilling activity, improved pricing and strict cost control. Our Q1 adjusted EBITDA included a share-based compensation charge of $23 million. Without this charge, adjusted EBITDA would have been $166 million, which compares to $191 million in Q1 2023, a decrease of 13%. Net earnings were $37 million or $2.53 per share, representing the seventh consecutive quarter of positive earnings for Precision. Funds provided by operations and cash provided by operations were $118 million and $66 million, respectively. Margins in the U.S. and Canada were higher than guidance resulting from stronger-than-expected pricing, higher ancillary revenues and improved cost performance.

The importance of cost management and field margin generation cannot be overstated. And on this front, I’m pleased with the performance of the business. Reducing cost remains a high priority for me and I continue to work closely with the finance, operations and supply chain teams to demonstrate continued progress in 2024. In the U.S., drilling activity for Precision averaged 38 rigs in Q1, a decrease of 7 rigs from the previous quarter. Daily operating margins in Q1, excluding the impacts of turnkey and IBC were $1,057, a decrease of $755 from Q4, but significantly higher than guidance. For Q2, we expect normalized margins to be above $10,000 per day. In Canada, drilling activity for Precision averaged 73 rigs, an increase of 4 rigs from Q1 2023.

Daily operating margins in the quarter were $15,647, an increase of $2,089 from Q1 2023. For Q2, our daily operating margins are expected to be between $13,000 and $14,000. Internationally, drilling activity for Precision in the current quarter averaged 8 rigs. International average day rates were $52,808, an increase of 2% from the prior year due to rig mix. With the rig activations completed last year, we expect international EBITDA to increase approximately 50% from 2023 to 2024. In our C&P segment, adjusted EBITDA this quarter was $19 million, up 7% compared to the prior year quarter. Adjusted EBITDA was positively impacted by a 28% increase in well service hours and improved pricing, reflecting the higher demand for our services and the impact of the CWC acquisition completed in November.

We continue to create value with the CWC business on both sides of the border. And to-date, we have achieved $16 million of the projected $20 million of annual synergies. Capital expenditures for the quarter were $56 million and included $14 million for upgrade and expansion and $41 million for maintenance and infrastructure. Our full year 2024 capital plan remains at $195 million and is comprised of $155 million for sustaining and infrastructure and $40 million for upgrade and expansion. If increased rig activity materializes and upgrade demands continue, our capital plan could increase slightly in the second half of the year. As of April ‘24, we had an average of 46 contracts in hand for the third quarter and an average of 44 contracts for the full year 2024.

Moving to the balance sheet. Our Q1 results reflect the seasonal working capital build within our business and onetime payments highlighted in our press release. During the second quarter, we expect to have a – during the first quarter, we had a slight decrease in cash, as we have lower seasonal activity in Canada during the second quarter and no semiannual interest payments. Cash is coming in the door, and we expect to begin reducing debt in Q2. As of March 31, our long-term debt position net of cash was approximately $900 million, and our total liquidity position was over $600 million, excluding letters of credit. Our net debt to trailing 12-month EBITDA ratio is approximately 1.5x, and our average cost of debt is 7%. We expect our net debt to adjusted EBITDA before share-based compensation expense to continue to decline throughout the year.

And we are committed to reducing debt by $600 million between 2022 and 2026 and achieving a normalized leverage level of below 1x. Our debt reduction target for 2024 is $150 million to $200 million, and we plan to allocate 25% to 35% of free cash flow before principal payments directly to shareholders. Based on the robust free cash flow outlook, we were repurchased $10 million of shares during the quarter, twice the pace of last year, a pace we plan to meet or exceed throughout 2024. Moving on to additional guidance for the year, which remains largely unchanged from the prior call. We expect depreciation of approximately $290 million, cash interest expense of approximately $75 million, cash taxes to remain relatively low and our effective tax rate to be approximately 25%.

Selling general and administrative expenses of $100 million before share-based compensation expense. We expect share-based compensation charges for the year to range between $40 million and $50 million at a share price range of $80 to $100 and the charge may increase or decrease by up to $15 million based on the share price performance relative to Precision’s peer group. With that, I’ll turn the call over to Kevin.

Kevin Neveu: Thank you, Carey, and good afternoon. As Carey described, our business is performing very well. From a market perspective, our customers are in an extended period of increasing technology adoption and rig high-grading, which aligns perfectly with our high-performance and Alpha technology-focused competitive strategy. Our team is achieving strong safety execution, excellent rig efficiency and delivering highly disciplined cost management. We see firm day rates and stable margins across our business with excellent incremental growth opportunities in Canada and the Middle East. We expect normal maintenance investments and some upgrade investments while yielding strong free cash flow for the foreseeable future. For our investors, the majority of our heavy lifting on debt reduction is almost complete.

And as Carey mentioned, we have prioritized increasing the turn of capital to shareholders. I believe all of this demonstrates the success of our long-term strategy and the value we offer our shareholders. Moving on to the Lower 48. Industry rig demand remains muted by weak natural gas prices and operator consolidation. While the leading indicators we monitor continue to point to a likely rebound in demand, the timing of that rebound is not clear. Those indicators include oil prices trending in the range of the upper 70s to lower 80s, exhausted inventories of drilled and uncompleted wells, a wave of LNG export facilities set to commence operations late this year and into next and ongoing operated discussions regarding high-grading rigs once the consolidating transactions are complete.

Yet the visibility and timing of rebound is not clear, and we expect a muted demand will persist during the second quarter.

Northern Rockies : Turning to Canada. It’s a much different story. If the question is, do we see customer interest increasing in anticipation of the Trans Mountain start-up? The answer is resoundingly yes. Today, we have 48 rigs operating compared to 38 this time last year. 9 of the 10 rig increase are Super Singles targeting heavy oil. We see this momentum continuing throughout the summer and exceeding our prior view on Canadian rig demand. With our pad equipped Super Singles fully utilized, several customers are seeking to upgrade additional Super Singles to Pad our rigs. These $2 million to $3 million upgrades come with market-leading day rates and long-term take-or-pay contracts. During the winter drilling season, we peaked up 43 Super Singles, operating and surprisingly expect to get back to that range during mid-summer as activity recovers from spring breakup.

However, like the Lower 48, the weak natural gas price has been a drag on some Canadian dry gas activity with some operators reducing or delaying near-term gas projects. The impact on Precision has been negligible as Super Triple demand remains very strong with year-over-year activity for Precision flat and our fleet essentially fully utilized. Despite the weak AECO pricing, customer sentiment for nat gas remains surprisingly positive. The Coastal GasLink pipe is complete and LNG Canada is targeting final commissioning later this year with first gas shipments to follow. Based on preliminary customer conversations, LNG shipments will reinforce demand for our Super Triples like we’ve experienced in heavy oil with our Super Singles. It appears that customer demand will exceed Super Triple rig supply and we may have the opportunity to mobilize additional capacity from the U.S. back to Canada early next year.

Currently, we have 48 rigs running and expect trend to the mid-60s by the end of June and into the 70s in July, well ahead of last year’s pace. Keep in mind that during the Canadian spring and summer, weather and forest fires may have a temporary impact on activity, but should that happen, we expect it would serve to increase demand later in the year as those projects delay projects pile up. On our February earnings call, we mentioned that we deployed to the field, the NOV Adam rig floor and derrick robotic pipe handling system. This is essentially a bolt-on robotic system, which can be installed on any Precision Super Triple drilling rig. The first system is performing much better than I expected, with 97% of all rig floor and derrick pipe handling operations fully automated.

We have no people working on the rig floor or up in the racking board. Now of course, this is a highly sophisticated system, and we expect several more months of field hardening to fully commercialize this product. However, in just the first 65 days of operations, we’ve drilled over 15,000 meters and that’s 50,000 feet for our U.S. listeners. We’ve tripped over 60,000 meters or almost 200,000 feet of drill pipe. We’ve completed 8 whole sections that run the casing for all those sections with the robotic system. We believe that once we have fully field hardened and commercialized item, we will match or exceed the maximum efficiency possible with manual pipe handling. We’ll eliminate human work from the red zone on the drill rig floor and in the mast while ensuring our customer safe, consistent, predictable and highly efficient rig floor performance.

Our early operational success with the NOV robotics system mirrors the technical success we’ve previously achieved with our Alpha Automation, Alpha Apps and EverGreen initiatives. Most importantly, it demonstrates our approach to new technology development. I’ll remind you that our technology strategy has been to collaborate with industry partners who invest in the product R&D while we focus on field deployment and field hardening. Our technology team is comprised of highly experienced engineers and operations experts who work hand-in-hand with our field operations management team to ensure new technology is deployed with a well-supported highly structured process. The process is designed to learn and solve deployment challenges quickly and efficiently with minimal cost over hits.

Our robotic system is well on this path, and we are the industry’s first mover with field robotic technology. We believe that the comprehensive skills and operational IP, we are developing because we feel harden the system reinforces our first-mover competitive advantage and does so with virtually no overhead burdening our financial performance. Now turning to our Canadian Well Service Group, the TMX tailwind is having a similar impact on well servicing demand. During the first quarter, Precision Well Servicing averaged daily two active rigs with peak utilization exceeding 100 rigs several times. On a snapshot in time basis, today, we are running 65 well service rigs, which compares to approximately 40 rigs for Precision and CWC combined at the same time last year, and we expect this demand profile to continue.

With the CWC acquisition, our team has leveraged our scale with significantly increased access to labor and a larger customer base, we have widely expanded our capabilities across Western Canada Sedimentary Basin. Customer demand through the year is expected to remain strong, driven by the improved oil price differentials, supporting activity in oil-focused areas and increased abandonment spending for the remainder of 2024 and into 2025. Moving to our international business. In Kuwait and the Kingdom of Saudi Arabia, we continue to bid our idle rigs for opportunities in both markets and also for other opportunities in the region. Now competition in these regions has increased as other international drillers are looking to enter the Middle East.

The eight Precision rigs currently running are delivering a 40% activity growth for Precision. We believe there are good opportunities to activate additional rigs this year or early next year as we look to continue our growth in that region. So I’ll wrap up our comments by thanking the people of Precision for their hard work and dedication and the excellent results they are achieving for our customers, for our investors and for the company. With that, I’ll now hand the call back to the operator for your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Aaron MacNeil with TD Cowen. Your line is open.

Aaron MacNeil: Afternoon. Thanks for taking my questions. As we think about the sort of outperformance in the U.S. relative to margin guidance and then the guidance for that step down in Q2 to, I think, $10,000 per day what are the sort of puts and takes for the sequential decrease? Like is it pricing? Are costs increasing? Are you just sort of embedding some continued conservatism in the guide?

Carey Ford: Aaron, I think it’s a little bit of all of the above, a little bit of pricing pressure and just maintaining a little bit more fixed cost with the lower activity level, puts a bit of pressure on the margins, but we feel pretty good about being able to exceed the $10,000 a day mark.

Aaron MacNeil: Got it. Okay. And then maybe just a clarification question for you, Carey. I know obviously, the shareholder returns piece is becoming a bigger focus, just wondering, could you define how you calculate free cash flow so we can sort of make our own assumptions around how – like what the order of magnitude might be on the buyback.

Carey Ford: Yes. I mean I think in dollar terms, think of it as kind of a $50 million to $100 million is probably the range in dollar terms, but we look at free cash flow as EBITDA less interest, less CapEx. And that is what we have available for debt reduction and share buybacks.

Aaron MacNeil: Excellent. I will turn it back. Thanks.

Kevin Neveu: Pleasure.

Operator: Our next question comes from Cole Pereira with Stifel. Your line is open.

Cole Pereira: Afternoon, all. So U.S. outlook is largely similar to your peers. But I’m just wondering, can you give some color on how customer conversations are going? Any big differences between public and private oil versus gas, etcetera?

Kevin Neveu: Hi, Cole, it’s Kevin. So fewer conversations on gas than oil these days, and that might be like 3 or 4 to 1. I’d say there isn’t a lot of difference in the type of conversations. But there is one unique piece. So we’re in conversations with many of the companies that are involved in transactions on the buy side. And there’s going to be a real push to move to higher technology rigs, consolidate vendor groups. So I’d say that there’s a high level of engagement right now with some of the larger E&Ps in the U.S. looking to understand how successful we’ve been with Evergreen and with the Alpha and even with our robotics automation. And I think as those transactions close and they begin to rationalize the rig fleets, I feel quite good about our positioning right now.

Cole Pereira: Okay. Got it. Thanks. And talked about a higher year-over-year rig count in Canada. I’m just wondering, do you see that for both heavy oil focused and gas-focused rigs in your fleet? Or is there kind of a shift more towards the heavy oil side? And then are you willing to say, on average, what those two different class of rigs might be generating right now from a margin per day standpoint?

Kevin Neveu: I’ll touch on the activity, and I’ll let Carey make comments on the margin. But – Cole, so the delta in activity so far has been oil-based – so – and it’s really kind of built up almost following the announcement of the pipeline had a firm start date. And I think that’s removed any uncertainty from anybody’s minds. Certainly, the WCS discounts has been in place for a little while now. So I think you’ve got better cash flows for oil. You’ve got very low geological risk on heavy oil drilling, very predictable drilling programs, highly efficient rigs. So I think it’s been an easy decision for our customers to very quickly get back to the drill bit and get back on programs that we’re running back in that 2010, 2011, 2012 time frame and do it now with the confidence of better takeaway capacity, good marginal discounts, that run a good supportive exchange rate.

On the gas side right now, I’ll be quite clear. We haven’t seen any drag due to natural gas prices. Our Super Triple activity remains firm and strong in the Montney. It does look like from conversations that once we’re closer to export start-up that we’ll start to see a response on increased demand on Montney rigs. So that’s why we’re thinking that the day LNG Canada announced that they’re commissioning and they’re going to be launching their first shipments, I think we’ll see a response on the gas side.

Carey Ford: Yes. And I’ll follow on there on the margin question. I think if you go back 3 or 4, 5 years ago, we had a pretty big difference in margin between Super Triples and Super Singles. That has changed as we’re close to 100% utilization on the Super Triples and very high utilization on the Super Singles now. Super Singles have a little bit lower operating cost, and they’re in demand, so the rates are pretty strong. So that difference is – there’s still a bit of a difference there, but it’s a lot narrower band than it used to be. But the activity difference between 2023 and 2024 is going to be made up of Super Singles and a few of the Tele-Doubles that we acquired in the CWC acquisition.

Cole Pereira: Okay. Got it. Thanks. And then just kind of to circle back on some of your comments. Fair to say that even with a bit of weakness in natural gas, you’re not really seeing any pricing pressure for those rigs?

Kevin Neveu: I think in the Super Single range in oil, there’s no impact whatsoever. And on the Triple side, we’re in negotiations with the clients right now. We’re getting lots of rhetoric back and forth around price tension with our customers like we always do. I think we’re working hard to make sure we keep our customers happy right now.

Cole Pereira: Got it. That’s all for me, thanks. I will turn it back.

Kevin Neveu: Thanks, Cole.

Operator: Our next question comes from Luke Lemoine with Piper Sandler. Your line is open.

Luke Lemoine: Yes. Hey, good afternoon. Kevin, just wanted to clarify, you talked about the Canadian rig count being in the 60s in June and ‘70s in Canada? Is that correct?

Kevin Neveu: That’s correct, probably in the mid-60s by the end of June and then into the mid-70s by mid-summer. There’s always a comment about whether if it rains hard, we lose rigs very quickly. So forest fires could cause an impact, but I’ll just leave those kind of at the sidelines for a moment. Customers have plans to activate rigs and they’re booking our rigs and they’re having us get our crews lined up to get in the range of 65 rigs by the end of June, 75 rigs in mid-summer. It’s unusual to see the rig count get that close to the winter rig count in the summertime. I mean I’m quite surprised.

Luke Lemoine: Yes. And then you – we talked about it in previous calls before, and you alluded to it again, possibly bringing your rigs up from the U.S. to Canada with, I guess, what kind of the Canadian rig count surprising here. Is there a possibility you can move more rigs to Canada from the U.S. than you previously expected? Or what do you think the outlook is on for that next year?

Kevin Neveu: It’s a little hard to say because, frankly, I’ve been a bit surprised by the response on the oil side to Trans Mountain. Certainly, we were not – we were planning to see 46 rigs or 48 rigs running in mid-April. It’s been a pleasant surprise. It does show you how quickly our customers here can respond to a better macro. On the gas side, I wouldn’t be surprised if we were requested by customers to move two or three more rigs up from the U.S. in 2025. We want them to pay the move cost. We want them to pay for any recertifications or upgrades to Canadian requirements. And we want day rates that are up in 30. So we’ve been quite clear on that. We certainly do not want to oversupply the market in Canada that’s proven to be really, really poor for our returns. We need to maintain decent returns for our shareholders. So ensuring that we bring rigs out there coming in at the same rate of return we’re getting on our current rigs is really important.

Luke Lemoine: Okay. And then on the U.S. rig count, totally get the choppiness, I think you’re 39% right now, switching on the press release, and you talked about adding one to two in the DJ here coming up this quarter. Is the right way to think about the 2Q rig count just kind of offsetting around this number? Or how should we handicap that?

Kevin Neveu: Yes, I’d like to see it stable 40%, but I think it will lostlate around 40%.

Luke Lemoine: Okay. And then I’ll sneak one more in. Carey, on the U.S. margins. You talked about a mixture of fixed cost, just kind of lower rig count, less absorption there and then some rate pressure as well. I mean would you characterize the rate pressure is pretty minimal at this point?

Carey Ford: Yes. I think that’s kind of – our guidance reflects that. It’s a little bit of higher cost and a little bit of rate pressure, but it’s less than $1,000 a day.

Luke Lemoine: Okay, got it. Thanks so much.

Kevin Neveu: Luke, I’ll just clarify one thing for you, if you don’t mind. You mentioned the DJ Basin. We’re actually looking kind of Northern Rockies into the Wyoming area for those rig additions.

Luke Lemoine: Okay, thank you.

Kevin Neveu: Great. Thank you.

Operator: Our next question comes from Keith Mackey with RBC Capital Markets. Your line is open.

Keith Mackey: Hi, thank you. Maybe just if we could start out on the shareholder returns front. So 25% to 35% of free cash flow you plan to return to shareholders this year. How does that change as you get towards your debt target. I think your release mentioned getting closer to that 50% mark. How do you think about that in terms of actual timing in versus achieving your debt reduction targets? Do you move it up before you actually get to the $600 million of debt reduction in 2026? Or do you think about it moving sooner than that? Just anything you can do to help us frame the timing on that would be great.

Carey Ford: Sure. Keith, the goal here is to get debt down to below 1x normalized level. So it’s going to depend on kind of where our EBITDA is in ‘25 and ‘26, where we think it’s going to be. But there’s a good chance we’re in that range next year. And if you look at today than in the last few years, we paid down $258 million of debt, if you take the midpoint of where we’re guiding this year, let’s call it $175 million of additional debt reduction. Your we’re kind of low to mid-4s there on debt reduction at the end of this year on a $600 million target. So I think we’re going to be well on our way and we’re effectively doubling our allocation to – on a percentage basis, our allocation to share buyback – and we’re already getting more confident in taking some of that free cash flow and using it to give direct payments to shareholders.

So I think that type of thinking will continue into 2025. And I can’t promise that we’ll be at 50% next year, but I think I can promise that we’re going to increase the allocation next year.

Keith Mackey: Got it. Okay. That’s helpful. And just a follow-up on that then, Carey, is it likely that you’ll continue along with the buyback in that scenario? Or do you think about a dividend as well or is it too early to tell?

Carey Ford: So we’ll have conversations with our Board every quarter about capital allocation and the form of the capital allocation. This year, it looks like it’s going to be share buybacks. But I think that as we move closer to our long-term goal of getting below 1x a dividend becomes more likely in one form or another.

Keith Mackey: Okay, thanks very much. That’s all for me.

Kevin Neveu: Good, thanks.

Operator: Our next question comes from Waqar Syed with ATB Capital Markets. Your line is open.

Waqar Syed: Thank you for taking my question. Kevin, as even the heavy oil basins, you see more and more pad drilling. Do you think that you could see maybe customer demand for Tele-Doubles with pad drilling capability kind of pick up more because you can store more pipe, do you expect to see that trend?

Kevin Neveu: I will look at this a couple of different ways, Waqar. First of all, we can store almost infinite pipe on our Super Single because pipes are that close only on pipe rocks. So, we are not limited on rocking capacity. The Super Single is an extremely efficient rig, and it’s got the pipe in the pipe arm right up against the well center line just before you need it. So, it’s a really efficient rig. It doesn’t require anybody in the direct to handle that pipe. So, it’s efficient, it’s safe. We can drill the first hole faster than a Tele-Double because we are not having to build double stands as we go. So, we are drilling ahead all the time. If it’s a single bit run type well, which a lot of these are, we can drill those faster than Tele-Doubles most of the time.

There has been some question in the past about the torque capabilities. We are addressing that. The rigs are being hydraulically upgraded to handle the torque. This has been a rig which has a – approaching a 40-year history in heavy oil as a highly efficient rig. And when you look at those drilling times, those rocking times, tripping times and then combine that with either the rocking time to walk well to well, we plan to move the rig. We can move that entire rig in four hours to five hours. That’s if we are moving it location-to-location. It is just an amazingly efficient rig. So, I think that I don’t ignore competition. We only have 55% market share, we don’t have at all, but I am pretty happy with what we have.