July13, 2007
Research Associate: Sharbari Nath, M.Fin. M.Com.
Editor: Jewel Saha, ACS
Sr. Editor: Ian Madsen, CFA 1-800-767-3771 x9417
111 N. Canal Street, Suite 1101Chicago, IL 60606
Patterson-UTI Energy (PTEN – NASDAQ) $25.04
Note:All new or revised material since the last report ishighlighted.
Reason for Report:Change in Estimates Previous Edition:June 04, 2007
Recent Events
On July 3, 2007, PTEN reported that for the month of June 2007 the company had an average of 247 drilling rigs operating, including 242 rigs in the U.S. and 5 rigs in Canada. For the quarter ended June 2007, the Company had an average of 237 drilling rigs operating, including 235 rigs in the U.S. and 2 rigs in Canada.
Overview
Analysts have identified the following factors for evaluating investment merits of PTEN:
Key Positive Arguments / Key Negative ArgumentsCompelling Fundamentals
- Substantial incremental returns on capital
- Strong balance sheet and cash flow
- Share buy back
- Refurbishing rigs giving cost advantage
- Refurbishments and new builds to increase fleet
- Late 2007 could see increasing rig activity caused by declining gas inventories, improving gas prices, and natural decline rates of the gas fields.
- Wage inflation likely to continue squeezing margins
- Increased maintenance costs through 2007
- Rising capex requirements a strain
- Financial performance particularly sensitive to the North American land drilling market
- Significant competition from nearly 400 new rigs entering the market.
- Non drilling demand appears subdued
- Volatile stock price due to limited visibility
- Volatile oil and gas prices
- Near term declines in NAM drilling activity expected
- Uncertainty over timing of demand pickup
- Unusual downtime or damage
- Weather-caused problems
Patterson-UTI Energy, Inc. (PTEN) provides onshore contract drilling services to exploration and production companies in North America. PTEN has approximately 340 currently marketable land-based drilling rigs that operate primarily in oil and natural gas producing regions of Texas, New Mexico, Oklahoma, Arkansas, Louisiana, Mississippi, Colorado, Utah, Wyoming, Montana, North Dakota, South Dakota and western Canada. PTEN is also engaged in the businesses of pressure pumping services and drilling and completion fluid services. Additionally, the Company has an exploration and production business. No customer provides more than 10% of operating revenue. The Company owns and operates 336 trucks and 439 trailers used to rig down, transport and rig up its drilling rigs. This reduces its dependence on third parties. PTEN employs approximately 9,000people. More information is available at its website PTEN operates on a calendar year basis.
Revenue
Total Revenue
Revenue ($ in M) / 1Q06A / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008E / 2009EDrilling / $508.7 / $553.3 / $467.5 / $409.1↔ / $2,169.4 / $1,765.8↔ / $1,880.6↔ / $2,393.6↔
Fluids / $49.2 / $37.1 / $30.8 / $31.4↔ / $192.4 / $140.8↔ / $154.1↔ / $190.0↔
Pressure Pumping / $31.3 / $37.9 / $38.6 / $38.6↔ / $145.7 / $154.5↔ / $167.3↔ / $190.8↔
Other/E&P / $8.5 / $10.1 / $10.3 / $9.5↔ / $39.2 / $37.8↔ / $37.5↔ / $44.5↔
Total Revenue / $597.7 / $638.4 / $547.1 / $485.7↔ / $2,546.7 / $2,071.4↔ / $2,233.6↔ / $2,493.6↔
Digest High / $597.7 / $638.4 / $547.1 / $492.2 / $2,547.0 / $2,311.0 / $2,482.0 / $2,818.8
Digest Low / $597.7 / $638.4 / $547.1 / $467.8 / $2,546.6 / $1,975.0 / $1,910.0 / $2,083.0
Y-o-YGrowth / -8.5% / -23.7% / 46.3% / -18.7% / 7.8% / 11.6%
Q-o-Q Growth / -5.2% / -14.3% / -11.2%
The Zacks Digest Average total revenue was $547.1M in 1Q07 versus $597.7M in 1Q06 and $638.4M in 4Q06 representing a y-o-y decline of 8.5% and a sequential decline of 14.3%. Average revenue per operating day during 1Q07 was $20,350, compared to $20,760 in 4Q06.
Contract Drilling
The Zacks Digest Average Contract Drilling revenue in 1Q07was $467.5M, down8.1% from $508.7M in 1Q06 anddown15.5% from $553.3M in 4Q06.
During the quarter PTEN had an average of 255 rigs operating, including 243 in the U.S. and 12 in Canada. This compares to an average of 290 rigs operating in the fourth quarter of 2006, including 278 in the U.S. and 12 in Canada.
Fluids
The Zacks Digest Average Drilling Completion and Fluids revenue was $30.8M in 1Q07 versus $49.2M in 1Q06 and $37.1M in 4Q06 representing a y-o-y decline of 37.4% and a sequential decline of 16.9%.
One firm (Lehman) believes weakness reflects slower activity levels which the firm expects to continue in future.
Pressure Pumping
The Zacks Digest Average Pressure Pumping revenue averaged $38.6M in 1Q07, up 23.3% from $31.3M in 1Q06 and up 2.0% from $37.9M in 4Q06. One firm (Lehman) believesPatterson’s pressure pumping business continues to remain strong with no significant impact from the break-up in the Appalachia region. Average revenue per job increased to $13.59 from $13.50 in the prior quarter. The firm also believes that this has been a steady business for PTEN.
Other /E&P
The Zacks Digest Average Other /E&P segment revenue was $10.3M in 1Q07,up 20.9%y-o-y from $8.5M in 1Q06 and up 2.0% sequentially from $10.1M in 4Q06.
Outlook
PTEN is moving ahead with reactivating 14 land rigs in 2007 all of which would be 1,000hp. Additionally, depending on demand conditions another 14 more rigs could be ordered, all of which would be 1,500hp.
One firm (Morgan Keegan) believes that the current level of drilling activity will be sufficient to increase natural gas production on an annual basis, but the level of drilling activity will not be sufficient to meet forecasted demand growth. The firm however hasa bullish implication for natural gas inventory levels and pricing and, therefore,there is a positive impact on drilling activity in the back half of 2007 as well as into 2008.
The Digest model forecasts total revenue of $2.07B for 2007, $2.23B for 2008,and $2.49B for 2009, reflectingay-o-y decline of 18.7% in 2007 and y-o-y growth of 7.8% in 2008and 11.6% in 2009.
Please refer to the PTEN Zacks Research Digest spreadsheet for specific revenue estimates.
Margins
Margins / 1Q06A / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008E / 2009EGross Margin / 51.1% / 49.0% / 44.8% / 40.8%↔ / 50.4% / 41.9%↔ / 39.8%↔ / 37.8%↔
Operating Margin / 41.1% / 39.1% / 34.0% / 27.1%↔ / 40.9% / 27.7%↔ / 26.7%↔ / 32.6%↔
Pretax Margin / 41.5% / 37.9% / 32.8% / 27.1%↔ / 41.0% / 29.3%↔ / 27.8%↔ / 32.9%↔
Net Income Margin / 26.5% / 24.5% / 21.2% / 17.5%↔ / 26.4% / 18.6%↔ / 17.6%↔ / 17.9%↔
The Zacks Digest Average operating income in 1Q07 was $185.9M versus $245.6M in 1Q06 and $249.5M in 4Q06 reflecting a y-o-y decline of 24.3% and a sequential decline of 25.5% respectively.
The Zacks Digest Average net income in 1Q07 was $115.9M versus $158.6M in 1Q06 and $156.3M in 4Q06 reflecting a y-o-y decline of 26.9% and a sequential decline of 25.8% respectively.
Lower income was due to increased average direct costs per operating day of $10,720, compared to $9,940 in 4Q06, primarily as a result of costs associated with deactivating drilling rigs and retention of skilled personnel.
Rig margins per day declined in 1Q07 to $9,630 from $10,820 in 4Q06.
Outlook
One firm (Jefferies) believesPTEN’s margins per rig day to decline approximately $1,300 in 2Q07 and potentially $800 in 3Q07.
One firm (Lehman) believes in the second and third quarter, margins may weaken further by roughly $1,300 and $800, respectively. The primary cause of the margin decline is soft dayrates versus higher costs. The firm also believes late 2007 should again see increasing rig activity as weather conditions become more favorable.
The Digest model forecasts operating income of $573.5M for 2007, $595.6M for 2008, and $813.3M for 2009, reflecting a decline of 45.0% in 2007, a growth of 3.9% in 2008, and 36.6% in 2009.
The Digest model forecasts net income of $386.1M for 2007, $393.1M for 2008, and $447.1M for 2009, reflecting a decline of 42.7% in 2007, and a growth of 1.8% in 2008 and 13.7% in 2009.
Please refer to the PTEN Zacks Research Digest spreadsheet for more details on margin estimates.
Earnings per Share
EPS (in $) / 1Q06A / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008E / 2009EZacks Consensus / $0.91 / $0.97 / $0.73 / $0.57 / $4.02 / $2.41 / $2.50
Digest Average / $0.91 / $0.97 / $0.73 / $0.56↔ / $4.01 / $2.39↓ / $2.47↓ / $2.72↓
Digest High / $0.91 / $0.97 / $0.73 / $0.84 / $4.03 / $3.44 / $3.64 / $3.57
Digest Low / $0.91 / $0.97 / $0.73 / $0.46 / $4.00 / $2.08 / $1.50 / $1.75
Y-o-Y Growth / -19.8% / -44.4% / 80.5% / -40.3% / 3.4% / 10.2%
Q-o-Q Growth / -13.3% / -24.7% / -23.9%
The Zacks Digest Average EPS was $0.73 in 1Q07 versus $0.91 in 1Q06 and $0.97 in 4Q06 representing a y-o-y decline of 19.8% and a sequential decline of 24.7%. The lower earningswas primarily a result of increasedaverage direct costs per operating day of $10,720 in 1Q07, compared to $9,940 in 4Q06.
Outlook
All the brokerage firms covering the stock have lowered the EPS estimate for 2007 because of lower utilization and dayrates in the domestic onshore drilling market and reduced activity level in North American land drilling market.
One firm (CapitalOneSC.) lowered its 2Q07 and FY07 EPS estimates due to unusually high precipitation in Texas and Oklahoma during the quarter. The firm has however maintained its 2008 EPS estimate.
One firm (Citigroup) lowered its 2007 EPS estimates from $2.40 to $2.35 to reflect continued weakness in U.S. spot day rates. The firm also lowered its 2008 EPS estimate from $2.80 to $2.60 as the lack of significant day rate recovery is likely to weigh on early 2008 results.
The Digest model forecasts EPS of $2.39 for 2007, $2.47 for 2008, and $2.72 for 2009, which reflects a y/y decline of 40.3% in 2007, a growth of 3.4% in 2008, and 10.2% in 2009.
2007 EPS forecasts (15 analysts) range from $2.08 (RBC Cap.) to $3.44 (Zacks Investment Research); the average is $2.39.
2008 EPS forecasts (15 analysts) range from $1.50 (Merrill) to $3.64 (Zacks Investment Research); the average is $2.47.
2009 EPS forecasts (3 analysts) range from $1.75 (Merrill) to $3.57 (Morgan Stanley); the average is $2.72.
Please refer to the PTEN Zacks Research Digest spreadsheet for more extensive EPS figures.
Target Price/Valuation
Of 15 analysts following PTEN,6 gavepositive ratings, 5gave neutral ratings, and 4gave negative ratings on the stock. None of the analysts has changed the target price since the last report. The Digest average target price of $28.86(↔ from the previous report, 15.26% upside from the current price) lies between the Digest high of $36.00(RBC Cap.)(43.77% upside from the current price) and the Digest low of $22.00(Deutsche Bank) (12.14%downside from the current price). The most common valuation methods used by the analysts are the application of P/E multiple on forward earnings estimate and the EV/EBITDA method. The analyst with the highest price target has used 17.3X FY2007E EPS as the basis of valuation methodology and the analyst with the lowest price target has used an estimate of mid-cycle EBITDA and PTEN's trading range relative to the broader market as the basis of valuation methodology.
Rating DistributionPositive / 40.0%
Neutral / 33.0%
Negative / 27.0%
Average Target Price / $28.86↔
Digest High / $36.00
Digest Low / $22.00
No of analyst with Target price/Total / 11/15
Risks to the price target include unusual downtime or damage experienced by the company’s rigs, delays due to weather, lack of adequate contracts,volatile commodity prices, high earnings and stock price volatility, as well as the company’s ability to implement day rate increases.
Please refer to PTEN Zacks Research Digest spreadsheet for further details on valuation.
Capital Structure/Solvency/Cash Flow/Governance/Other
Capital Expenditure
Capital expenditures for 1Q07 were $176M versus $114M in 1Q06. PTEN’s capital structure remains very solid with strong improving operating results and a disciplined acquisition strategy. One firm (Jefferies) believes PTEN still intends to maintain capex of $600-$650 million in 2007 in order to increase its marketable fleet by 15 rigs and continues to upgrade other rigs in its fleet.
Cash flow
Cash and cash equivalent in 1Q07 was $17M,as compared to $13M in 1Q06. One firm (AG Edwards) believes thatwith solidly improving operating results and a disciplined acquisition strategy, PTEN’s capital structure remains very solid. Even after capital spending of about $174 million, and paying off $120 million of long term debt, PTEN ended the quarter with cash of about $17 million. While capital spending has ramped up a bit due to rig reactivations and expansion in the pressure pumping business, operating cash flow should continue to grow and PTEN’s financial position is expected to remain strong.
Dividend
The company declared aquarterly cash dividend on its Common Stock of $0.12 per share, which was paid on June 29, 2007 to thestock holders of record as of June 14, 2007.
Other Discussion
On August 28, 2006, PTEN announced an agreement to purchase approximately $100M of rig components from National Oilwell Varco with scheduled delivery on various dates in 2007. The company plans to utilize these and other components in the construction of 15 new land drilling rigs. Activation of these 1,500 horsepower electric rigs is expected to begin in mid-2007.
Upcoming Events
August 03, 2007: Expected 2Q07 Earnings Announcement
Long-Term Growth
Out of thefirms following PTEN, only one firm (Merrill) has provided long-term growth rate of 10.0%.
Patterson has approximately 29% of its fleet on term contracts ranging from one to three years.
Analysts believe that onshore rig demand could continue to grow over the next several years as natural gas prices again begin to increase and operators continue to explore new areas like the Rocky Mountains, the Barnett Shale, and other regions in west Texas and the northwest U.S.
Individual Analyst Opinions
POSITIVE RATINGS (40.0%)
Johnson Rice – Overweight(no target price) – (05/04/07):The firm maintains an Overweight rating on the stock. INVESTMENT SUMMARY: The firm expects the market to remain unsettled throughout the middle of 2007, but expects conditions to improve later in the year and into 2008. From current levels the firm assumed roughly 20% reduction in spot pricing into 4Q07 before rebounding modestly in 2008.
Zacks Investment Research –Buy ($29) – (05/10/07): The firm maintains a Buy rating on the stock with target price of $29 per share. INVESTMENT SUMMARY: While the firm has lowered estimates to reflect the first-quarter drag and relatively weaker dayrate assumptions, it still remains positive about the long-term outlook.
AG Edwards – Buy ($34) – (05/03/07): The firm maintains a Buy ratingand a target price of$34 per share. INVESTMENT SUMMARY: The firms views PTEN's risk/reward profile as attractivedue to the stable North American market.
Citigroup – Buy ($31) – (07/06/07): The firm reiterates a Buy rating and the target price of $31 per share. INVESTMENT SUMMARY: PTEN is the most active drilling contractor in the US with a strong earnings potential but limited visibility, which it believes makes the stock volatile. The firm regards the shares to be attractively valued.
Lehman – Overweight ($32) – (05/04/07): The firm maintains an Overweight rating and the target price of $32. INVESTMENT SUMMARY: The firm believes the land drilling sector is bottoming in 2Q-3Q and should begin to improve with the progress of 2007.
Raymond James – Outperform ($32.50) – (05/03/07):The firm reiterates an Outperform rating buthas lowered the target price to $32.50 from $33.
NEUTRAL RATINGS (33.0%)
CapitalOneSC. – Hold ($26) – (07/11/07): The firm maintains a Hold rating andthe target price of $26 per share.
Bernstein – Market Perform ($27) – (05/04/07): The firm reiterates a Market Perform rating and a target price of $27 per share. INVESTMENT SUMMARY: The firm believes PTEN’s current valuation is appropriate.
Jefferies – Hold ($25) – (07/09/07): The firm maintains a Hold rating anda target price of $25. INVESTMENT SUMMARY: The firm believes with continued demand softness in the onshore rig market and more capacity entering the fleet, PTEN's share price adequately reflects the company's earnings growth prospects for this year.
Morgan Keegan – Market Perform (no target price) – (06/06/07): The firm has upgraded its rating on the stock from Underperformto Market Perform based on the assumption of increased rig counts. INVESTMENT SUMMARY: The firm notes that PTEN maintains a solid balance sheet in addition to being the largest active rig fleet among all land drillers and the company revenue stream is balanced through PTEN's completion fluid, pressure pumping, and oil and gas assets. However, slow day rate growth, volatility in commodity prices, and overexposure to North American land drilling will continue to pressure the stock.
RBC Cap. – Sector Perform($36) – (07/12/07): The firm has downgraded the rating from Outperform to Sector Performbut reiterates a target price of $36 per share. INVESTMENT SUMMARY: The firm continues to believe PTEN remains attractive for value players. The firm also believes PTEN offers good value at current levels.
NEGATIVE RATINGS(27.0%)
Deutsche Bank – Sell ($22) – (05/03/07): The firm reiterates a Sell rating and a target price of $22. INVESTMENT SUMMARY: The firm believes the pace of demand deterioration (utilization) appears to have slowed, pricing remains under pressure, and costs would continue to rise.
J.P. Morgan– Underweight (no target price) – (05/03/07):The firm maintains an Underweight rating on the stock. INVESTMENT SUMMARY: The firm is of the opinion that PTEN has more earnings risk.
Merrill – Sell (no target price) – (05/03/07):The firm maintains a Sell rating on the stock.
MorganStanley – Underweight ($23) – (05/04/07): The firm maintains its Underweight rating with a target price of $23 per share.
DROP OF COVERAGE
Friedman, Billings – (04/27/07): The brokerage firm has dropped coverage on the stock due to a reallocation of resources at FBR.
Research Associate: Sharbari Nath
Reviewed by:
Copy Editor: Salma Islam
Content Ed: Jewel Saha
Zacks Investment ResearchPage 1