Forum Energy Technologies: Valuation Concerns Before Potential Recovery (NYSE:FET)

FET faces downside

Forum Energy Technology Explained (New York Stock Exchange:FET) You can read past articles and latest articles. hereOver the past several quarters, oilfield services companies like FET have benefited from: The average footage drilled per rig has increased, the hydraulic fracturing phase has become longer, and the number of stages has increased. FET has jumped on the trend by introducing artificial lifts, wirelines, and advanced technology-based products. Over the past few quarters, the company has complemented his Artificial Lift product portfolio following the acquisition of Variperm. Orders for the artificial lift and downhole sectors rose in the first quarter, pointing to a strong recovery in the second half of 2024.

However, demand for coiled tubing and drilling equipment decreased in the international market as international operators reduced their capital investment budgets. The company’s cash flow improved in the first quarter, but debt levels soared after acquiring Variperm. What FET expects We expect cash flow to further improve in the second half of 2024, allowing us to repay a significant portion of our debt. The company’s stock is reasonably valued compared to its peers. In my view, valuations may improve in the medium term, but given the extent of valuation growth, they may decline in the short term. My prediction is that the stock price will fall further, reaching a bottom that reflects low profit margins and high leverage. Therefore, I rate the stock as a “sell.”

What is the reason for lowering the rating of FET?

In the previous iteration, we explained how low demand for products and services in pressure pumps is having a negative impact on FET. However, bookings for orders, especially for coiled tubing, accelerated. The company’s recent highlight has been the acquisition of Variperm, which should increase its scale and profitability.I I have written:

I don’t see the drilling and completions market turning around anytime soon in North America. While the resurgence of offshore projects is encouraging, the long payback period means that the benefits may not be realized over the medium term.

In 2024, we expect FET’s artificial lift and pump products and digital services to drive demand. The benefits from the Variperm acquisition still have room to fill the coffers. However, the company faces challenges including the uncertainty of Canada’s energy business, low natural gas prices and short-term seasonality. Additionally, net debt increased due to additional borrowings resulting from acquisitions, increasing the valuation multiple. Since the last article, the stock price has fallen 20%. I overestimated the recovery in the energy market and could not have predicted that natural gas prices would continue to fall. We downgraded the rating from “hold” to “sell” after considering various factors and the valuation outlook.

Industry drivers and prospects

At the beginning of 2024, oil prices were stable, but natural gas prices remained weak. US rig counts saw little visible change in his 2024 (down 3%) and flux counts recovered (up 9%). International rig numbers will be added to his number in 2024. However, tight budgets for international operators could slow demand growth in the second quarter.

During the first quarter, demand in FET’s wireline business recovered, particularly for premium greaseless cable systems. However, uncertainty prevails in Canada regarding the launch of the Trans Mountain Express pipeline. Adverse seasonal effects may also impact his FET’s performance in Canada. Additionally, Variperm’s first quarter results were quite good, but did not exceed expectations.

I expect sand oil activity in Canada to pick up pace in the second half of 2024, while I expect customer capital spending to increase in the U.S. and international markets. As a result of relatively stable energy activity, FET now expects second-quarter revenue and adjusted EBITDA to increase 4% and 14%, respectively. My estimates for the company’s sales and earnings growth are more modest, as explained below.

my estimate

After the Variperm announcement, the company estimated that the acquisition would increase sales by 17% and EBITDA margin to 14%. I think the company is on track to meet its goals, given that Q1 sales increased his 9% and EBITDA margin expanded by 460 basis points. Due to near-term headwinds, I expect the company’s revenue growth to be lower (5%-6%) in the second quarter. We also expect adjusted EBITDA to increase modestly between 5% and 8% in the second quarter, given that the company’s EBITDA has remained largely unchanged over the past 11 quarters.

Strategic outlook

Proceeds from the sale of capital equipment account for nearly one-third of FET’s sales. Global rig counts and US frac spread numbers primarily drive performance in the drilling and completions sector. Over the past decade, the quality and efficiency of rigs has improved significantly, even as the number of rigs in the United States has declined. The company estimates that the average number of footage drilled per rig has increased two to three times during this period. Horizontal hydraulic fracturing involves longer and more stages, resulting in increased profits for the fracturing company. Therefore, the number of wells completed per fleet has increased by almost 60%.

Products that I expect will improve FET performance include the Greaseless Wired Cable System, FASTConnect Manifold System, FR120 Iron Roughneck, and Pump Saver Plus. Over the past few years, the company has set up manufacturing and distribution locations in strategically important regions. We also reorganized our business segments from three to two. These efforts should reduce costs and improve profit margins in the medium to long term.

New order

FET’s artificial lift and downhole segment orders increased in the first quarter compared to the previous quarter. The sector saw an 89% increase in new orders, while the drilling and downhole sector saw a 2.5% increase in new orders. Investors should note that the sales ratio improved to his 1.01x in the first quarter. This suggests increased visibility into consumables and activity-based revenue in the coming quarters. The company also expects high fees from its capital-intensive, project-based business to lead to higher sales.

First quarter performance analysis

As announced in the first quarter results released As announced on May 2, FET’s first quarter revenue increased compared to a quarter ago, primarily due to faster sales growth (up 42%) in the artificial lift and downhole divisions (9 %). The segment’s revenues benefited from additional sales from the Variperm acquisition and increased sales of artificial lift and casing equipment. The segment’s adjusted EBITDA margin nearly doubled in the first quarter due to favorable product mix. As explained earlier in the article, the near-term sales outlook is also solid given the strong increase in new orders.

However, sales in our Drilling and Completed Products segment decreased in the first quarter due to lower international coiled tubing sales and lower demand for drilling equipment. However, adjusted EBITDA margin improved sequentially. In our previous article, we discussed how the Variperm acquisition increases FET’s scale and profitability.

cash flow and debt

The company’s operating cash flow turned slightly positive in the first quarter of 2024, compared to negative $23 million in the same period last year, primarily due to higher year-over-year revenue. As a result, free cash flow also turned positive in the first quarter of 2024. FET’s management expects fiscal 2024 free cash flow to be in the range of $40 million to $60 million. The company also expects its stable outlook to boost FCF in the second quarter.

FET liquidity is $121 million as of March 31, 2024. The debt-to-equity ratio was 0.64 times, more than double compared to FY2023. During the first quarter, long-term debt increased in connection with the Variperm acquisition. However, at the end of 2023, the maturity date of the revolving credit facility was extended to September 2028. With sufficient liquidity and improved cash flow, we expect to retire $134 million by fiscal 2024. In the medium term (next 5-6 quarters), the company plans to repay long-term debt and increase net debt to EBITDA to 1x.

Given the low operating margin growth rate, I think achieving the FCF target may be difficult. However, I agree that his FCF in 2024 will improve compared to his one year ago. As such, our FCF may not be sufficient and we may be required to redeem our $134 million senior secured notes by utilizing our revolving facility or refinancing our debt.

Risk factors and challenges

FETs operating in the energy sector will continue to face fluctuations in energy prices. Although oil prices are stable, falling natural gas prices could hinder the country’s growth. Another risk factor relates to upstream industry consolidation as players seek to achieve economies of scale and price concessions. The emphasis on non-traditional energy may also reduce demand for FET’s products and services.

Currently, the company is facing challenges due to flat rig counts worldwide. Uncertainty surrounding construction of the Trans Mountain Express pipeline could reduce Canadian demand for oilfield services. Seasonal weakness in international markets forced some customers to reduce their capital investment budgets at the beginning of the year. The lack of momentum could dampen FET’s second-quarter results.

Relative evaluation

FET’s multiple future EV/EBITDA contractions to current EV/EBITDA ratios are steeper than its peers. Therefore, the company’s adjusted EBITDA is expected to grow more significantly than its peers over the next four quarters. This typically results in a higher EV/EBITDA multiple for him. The current EV/EBITDA multiple (7.9x) is higher than its peers (NINE, OIS, PTEN). Therefore, the stock price is reasonable at this level compared to its peers. However, it is trading at a significant discount compared to its historical average (15.6x).

If it trades at the industry average over the medium term, it could fall 35% from current levels. I expect the acquisition benefits to help overcome some of the immediate margin pressure. As explained earlier in this article, he expects adjusted EBITDA growth in 2024 to be between 5% and 8%. If we enter these values ​​into the EV calculation and assume a future EV/EBITDA multiple hold, the stock could trade between $7.6 and $8.4, which means about $55. % downside.

target price

However, changes in net debt will have a disproportionate impact on EV ($539 million). The company’s valuation could rise if it fulfills its promise to pay down $134 million in debt in fiscal 2024. I believe the company’s EV/EBITDA multiple will expand to at least half of the past five years’ EV/EBITDA multiple of 15.6x, which could result in a higher stock price than my valuation discussed above.

I believe this stock can trade between $13.5 and $14.5, or about a 25% discount to its current price. However, if the company refinances its debt structure, the downside could become more pronounced.

What is a take-on FET?

In 2024, we expect products such as greaseless wired cable systems, FASTConnect, FR120, and Pump Saver Plus to drive demand for the company. We have strategically located our manufacturing and distribution locations to reduce costs. The acquisition of Variperm has been found to complement FET’s offerings in its artificial lift product portfolio and improve its operating margins and cash flow metrics. Improving rig quality and rig efficiency will also maintain the health of U.S. energy production and oilfield services companies.

However, operational uncertainty, seasonality, and budget constraints of international upstream carriers may limit growth in the short term. Therefore, the stock’s price is VanEck Vectors Oil Services ETF (OIH) past year. Also, the company’s leverage deteriorated after the acquisition of Variperm. If debt can be reduced as cash flow improves, the relative valuation multiple may rise. However, I see some downside to the current stock price in the short term due to the operator’s limited capex budget and FET’s high debt levels. Therefore, I would like to rate it as a “sell” again.