Helmerich & Payne (NYSE:HP), the Tulsa-based drilling company, has recently wrapped the first quarter of the 2020 fiscal year. Both revenue and earnings per share topped Wall Street’s expectations and triggered bulls, but the stock is still down compared to February 2019. The silver lining is that capital appreciation and dividend yield are antithetical; HP still offers a market-leading yield of around 6.3%.
As there is a plethora of data available, now it’s time to reassess my dividend investment thesis initially presented in September 2019 and revise my rating, if necessary.
Primary focus on cash flow
While the Q1 2020 GAAP net income per share surpassed analysts’ estimates and climbed to $0.27, the essential concern of a dividend investor is not accounting profit but operating cash flow together with capital intensity and free cash flow.
Profit might be misleading, too bloated or too devastated, as it does not factor in the impact of working capital and also reflects non-cash expenses or benefits; above all, a company pours not profits but cash flows into shareholder coffers, and if it posted positive EPS but failed to collect receivables or sufficiently cover capex, especially if cash balance has been shrinking, it will have to reassess its dividend distributions.
So, while the trailing twelve-month revenue of HP was in decline, primarily because of some softness in the U.S. shale industry and its inevitable repercussions that have taken a toll on the U.S. Land segment, its TTM operating cash flow also crept lower to $758 million.
Among other things, as it was clarified in the news release, quarterly cash flow reflected the impact of “the timing of certain accruals and payments” along with “a seasonal slowdown in receivable collections.”
However, surprisingly, compared to calendar 2018, net CFFO was up 10%. Also, capital expenditures, another essential metric for dividend investors, slid to the lowest level since fiscal 2017. Compared to fiscal 2019, the last twelve-month capex was scaled back by more than a third; it stood at $308.3 million, close to the lowest level in the decade. With sales of property factored in, net investments in PP&E were even lower and amounted to $257.2 million.
The capital intensity expressed as Gross capex/Sales also reduced to only 11.5%, well below the five-year average of around 23%. The key conclusion that can be drawn here is that HP’s growth was put on pause, which is reasonable and consistent with the overall barely buoyant market environment. Now it is unnecessary to expand its already modern and technologically advanced rig fleet, and capital expenditures were mostly used to offset depreciation.
So, meticulous working capital management, resilient cash flow despite weaker rig margins, and reduction in capital investments are all the necessary ingredients of the robust free cash flow recipe and adequate dividend coverage. As of my calculations, in the trailing four quarters, HP generated $500.9 million after covering net capital investments; annual dividends and share buybacks in turn added up to $359.3 million. So, shareholder rewards were 2.1x covered by net CFFO and 1.4x by free cash flow.
In Q1 2020, HP converted operating revenue of $661.4 million into a cash flow surplus of $77.7 million. Unfortunately, this amount was not above shareholder rewards, but the silver lining here is that inorganic free cash flow that factors in all investing activities was around $88.8 million, which was fairly enough to cover both dividends and share repurchases.
Besides, Helmerich & Payne has a minuscule net debt due to $412.05 million in cash, cash equivalents and short-term investments on the balance sheet and the Net debt/Net CFFO of 0.09x.
Return on Capital
Q1 2020 GAAP EPS reached $0.27, but in calendar 2019, Helmerich & Payne did not turn a profit. Negative earnings yield is somewhat disappointing, but again, not critical if we are examining the company’s performance from a dividend investor standpoint.
I am also content with its sub-zero Return on Equity, as this metric is of secondary importance to me. ROE is of no use when we try to measure if a company is cash-strapped. So, it is better to replace ROE with Cash Return on Equity or Cash Return on Total Capital.
As of my calculations, in 2019, HP’s Cash ROE (Net CFFO/Average Equity) was above 18%, a fairly decent result.
It also generated around $0.11 in free cash flow per every dollar of total capital. The result is excellent; the only conclusion I can make here is that the company is run by highly proficient and experienced professionals who are well-versed in lucrative capital allocation.
2020 is anticipated to remain lackluster as HP’s customers still scrupulously manage their capital budgets while WTI price remains under pressure. The CFO mentioned that the company expects capital expenditures of oil producers to be revised down by 10% compared to 2019. That is entirely true. For a broader context, Marathon Oil (NYSE:MRO) has recently presented its Q4 results and mentioned its 2020 capex would go down 10% to $2.4 billion.
The capex reduction trend is explainable, as upstream players ponder how to balance growth, returns, and balance sheet strength amid weak oil prices and not face a predicament. Unfortunately, this will inevitably cause more pressure on the top lines of the oil field services & equipment companies.
Expectedly, analysts anticipate fiscal 2020 revenue to fell 12%, followed by slow low-single-digit growth in 2021-2022. With the stable cash flow margin, we might expect FY 2020 net CFFO to go down to around $698.6 million. As it was mentioned on page 4 of the news release, FY 2020 gross capex is forecasted to be between $275 million and $300 million. Asset sales of $35 million-$45 million will likely reduce this figure by at least 12%. So, all these transforms into the free cash flow of approximately $458 million, adequate enough to finance annual shareholder rewards.
The outlook for the OFSE industry in the U.S. remains somewhat somber, but I see no fundamental reasons for Helmerich & Payne to scale its dividend back in 2020. Even amid the slowdown, the company retains a substantial market share in the U.S. thanks to its modern super-spec fleet and “customer preference for advanced drilling rigs.” Moreover, as the CEO said during the call, HP increased market share in the U.S. land rigs by 2% to 24%.
In sum, I consider HP an attractive, high-yield dividend stock.
I also understand growth investors have their reasons to steer clear of HP, as stuttering shale growth weighs on its revenue, and in the short term, it is highly unlikely the company will deliver material sales expansion.
Another parameter worth bearing in mind is the ripple effects of the coronavirus outbreak that has already fueled concerns that oil demand would be under pressure. The appraisal of the epidemic’s magnitude is questionable, as China has recently reported dramatic spikes in the number of infections which points to the fact previous methodology was not precise enough; the corollary here is that the oil market might not price the coronavirus impact accurately, and the pressure on WTI and Brent might increase. This, in turn, might provoke another series of capital budget reductions and add to the difficulties of the OFSE companies.
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.