Image Source: KLX Energy Services
By Callum Turcan
KLX Energy Services Holdings Inc (KLXE) is the product of a major corporate restructuring, as the oilfield services side of KLX was spun-off to shareholders while the aerospace business was acquired outright by Boeing Company (BA) in an all-cash deal worth $4.25 billion (including the assumption of $1.0 billion in debt) last year. Going forward, the new KLX Energy Services is focused on providing well completion, well intervention, and drilling services to America’s upstream oil & gas industry. A key consideration is that as a more focused enterprise, KLX Energy Services should be able to better perform in a tough space to be in right now. Note that the company does not pay a dividend at this time.
The oilfield services industry of today isn’t the same industry it was back in the 2000s and the first half of the 2010s. Global raw energy prices are relatively subdued, upstream capital expenditures haven’t recovered from the precipitous drop witnessed in 2015 and 2016, and the oil & gas industry as a whole is a lot more focused on keeping costs contained than in the past. This means terrible margins and limited growth potential, at least for many firms in this space, so picking out a quality oilfield services company is like finding a diamond in the rough.
What KLX Energy Services has done well so far, keeping in mind it’s a very new enterprise, is accept its new role. Oilfield services providers perform best when they can offer a slate of specialized services, instead of leaning heavily on just one or two product offerings. That involves investing in the business, something KLX had long neglected to do as it was first-and-foremost an aerospace company.
New Product Lines
KLX Energy Services purchased Motley Services, defined as a “a leading large diameter coiled tubing service provider” by the press release, for $148 million in October 2018. That consisted of $139 million in cash and $9 million in KLX Energy Services’ stock. Coiled tubing services are generally used for well intervention and well completion services.
That deal was funded primarily by KLX Energy Services tapping capital markets and raising $250 million by issuing senior notes due in 2025. Management plans to roll out new product service lines this year, which will see KLX Energy Services better market its new coiled tubing services alongside existing offerings. This purchase is partially what underpins KLX Energy Services’ bullish outlook for 2019.
Note that KLX Energy Services’ fiscal year ends in January. During its 2017 fiscal year, the company generated negative net operating cash flow of $9 million which clearly came nowhere close to covering $49 million in capital expenditures. Fast forward to fiscal 2018, and KLX Energy Services was able to generate $62 million in positive net operating cash flow. Management allocated a lot more towards capital expenditures last fiscal year in order to bulk up the business and put the company in a position to market a deeper slate of oilfield services. KLX Energy Services spent $84 million on capital expenditures in fiscal 2018, meaning it was still free cash flow negative.
Going forward, management expects the company to generate annual revenue growth of 50% in fiscal 2019 (the firm grew its top line by over 50% in fiscal 2018) and that is expected to drive annual adjusted EBITDA growth of 75%. The company’s bottom line is expected to surge by 70% year-over-year and management sees adjusted EPS of $4.50 for fiscal 2019. Purchasing Motley Services and rolling out new product lines lends credence to that guidance.
The company is supported by $164 million in cash on hand at the end of fiscal 2018 and an undrawn revolving credit facility with $100 million in lending capacity. Until KLX Energy Services files its 10-K for fiscal 2018 we won’t get a better breakdown of its balance sheet, but assuming its total debt burden stems entirely from the $250 million 2025 senior note issuance, the firm exited fiscal 2018 with a net debt position of $86 million. It’s imperative that the company starts generating free cash flow at some point in the near future, but we are cognizant of the transformation story currently playing out.
Very Tough Times
On the basis of its adjusted EPS guidance of $4.50 for fiscal 2019, KLX Energy Services’ current share price of $24.65 seems really cheap but note that the firm isn’t free cash flow positive and carries a significant net debt position. KLX Energy Services is a risky investment operating in a capricious market that even the heavyweights like Halliburton Company (HAL) and Schlumberger Limited (SLB) are having a very tough time navigating. During its latest quarterly conference call with investors, Halliburton noted that both its revenue and margins were coming under pressure in the near term:
Turning now to our near-term operational outlook, market dynamics continue to make forecasting a challenge. But let me provide you with some comments on how we believe the first quarter is shaping up…
North American results will be impacted by near-term headwinds that Jeff described earlier. We will continue to pull the levers that enable us to keep generating positive cash flow for our businesses. As such, in our Completion and Production division, we expect sequential revenue to decline mid- to high-single-digits, with margins decreasing 300 to 400 basis points.
For our drilling and evaluation division, we anticipate sequential revenue will experience a decline in the mid- to high-single-digits, largely in line with prior year declines, with our margins declining by 100 to 150 basis points.
If Halliburton is coming under fire, KLX Energy Services is also likely to feel some heat. Schlumberger was asked about its margin expectations for 2019 during its latest quarterly conference call and management replied that “we are heading into some headwinds in U.S. land on the production side going into 2019.” Reading deeper into management’s commentary, it appears Schlumberger expects the first half of this year to be rough with upside coming from a potential rebound in unconventional upstream capital expenditures later on (meaning greater investments in unlocking hydrocarbons from shale and other formations). That would almost entirely be a product of higher global oil prices, something that is far from certain.
When looking at raw American oil & gas production levels, it would seem like the oilfield services business should be just raking in dough, but that growth came at the expense of the entire oilfield services industry’s margins. New contracts are often signed at rock-bottom rates in order to keep the lights on. That can clearly be seen by the precipitous drop (see here) in the industry’s operating margin, return on invested capital, and return on equity from the 2013-2014 period (the glory days) to the 2015-2016 period (the nadir of the most recent prolonged oil pricing bust). Margins rebounded in 2018, but that was when West Texas Intermediate was flirting with $70 and unconventional upstream companies were aggressively ramping up spending to capitalize on that. Since then, the oilfield services industry’s margins once again eroded away as WTI slid back below $60. There can be only so much specialization within the oilfield services industry, a lot of the industry’s offerings have become commoditized over the years.
Concluding Thoughts
KLX Energy Services posted tremendous top and bottom-line growth during fiscal 2018 and great margin expansion. That being said, KLX Energy Services was still free cash flow negative, and it carries a material net debt load. While an interesting company and one we will keep on our radar going forward, KLXE is a risky investment in a tough market that even the bigwigs are having trouble navigating. The risks are too great for us.
Energy Equipment & Services (Large): BHGE, FTI, HAL, NBR, NOV, SLB, TS, WFT
Energy Equipment & Services: CLB, DRQ, FI, HLX, HP, OII, OIS, PDS, PTEN, SPN
Related ETFs: USO, XLE, OIL, UWT, UCO, XOP, DWT, OIH, SCO, BNO, DBO, DTO, USL, OLO, SZO, OLEM, WTIU, OILK, OILX
—–
Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free.
Callum Turcan does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.