imaginima
Last week, OPEC decided to reduce its production by 2 million barrels per day. As a result, the price of oil enjoyed a steep rally last week. Patterson-UTI Energy (NASDAQ:PTEN) is likely to greatly benefit from this strategic move of OPEC, as North American oil producers will almost certainly increase their production amid higher oil prices. However, the oilfield services provider remains risky from a long-term perspective.
Business overview
Patterson-UTI provides onshore oilfield services and products to oil and gas producers in the U.S. and Canada. Its two primary segments are the contract drilling and pressure pumping segments, which generate 49% and 38% of total sales, respectively.
Patterson-UTI incurred a fierce downturn due to the coronavirus crisis in 2020. Drilling activity collapsed in that year and thus the company posted excessive losses per share (-$4.27). As those losses were 30% of the current market capitalization of the stock, it is easy to understand the impact of the pandemic on the company.
Fortunately, U.S. drilling activity has almost returned to pre-pandemic levels thanks to the recovery of global oil consumption and the ongoing war in Ukraine. Due to the sanctions imposed by western countries on Russia for its invasion in Ukraine, Russia has reduced its production by about 1 million barrels per day. As a result, the U.S. and Canada have returned close to record production levels, as they have replaced some of the lost barrels of Russia.
Even better, the recent decision of OPEC will probably provide a strong tailwind to the business of Patterson-UTI. As most OPEC members already produce less oil than their quotas, the decision of OPEC essentially means that its members will reduce their output by approximately one million barrels per day. Consequently, the global oil market will become tighter. This helps explain the 12% rally of the oil price last week. In addition, a significant portion of the lost barrels from OPEC will almost certainly be made up by North American oil producers, who are among the very few producers worldwide who can enhance their output. As a result, Patterson-UTI is likely to enjoy increased demand for its products and services in the upcoming quarters.
However, it is important to note that Patterson-UTI was not profitable before the coronavirus crisis. The company has posted losses for seven consecutive years (with the exception of a marginal profit per share of $0.03 in 2017) even though the U.S. oil production rose to new all-time highs almost every single year until the onset of the pandemic in 2020.
The recurring losses of Patterson-UTI amid record U.S. oil production levels have resulted from technological advances, which have enabled oil producers to extract greater amounts of oil from a given number of rigs. In other words, oil producers are now able to extract more oil with fewer rigs and thus they have lower production costs per barrel than in the past. Consequently, as the revenues of Patterson-UTI are proportional to the number of operating rigs, the company generates lower revenues at a given production level than it did in the past.
Moreover, Patterson-UTI is currently facing a strong secular threat, namely the shift of the vast majority of countries from fossil fuels to clean energy sources. This trend has remarkably accelerated since the onset of the pandemic. It has accelerated even more this year, as most countries are suffering from the rally of the prices of oil and gas to multi-year highs. This rally has resulted from the sanctions imposed by Europe and the U.S. on Russia in response to the invasion of the latter in Ukraine. As most countries are currently going through a major energy crisis, they are doing their best to reduce their dependence on oil and gas. As a result, a record number of renewable energy projects is under development right now. When all these projects come online, in 3-5 years, they are likely to cause a severe downturn in the oil and gas industry. Patterson-UTI will be highly vulnerable to such a downturn.
Valuation
As mentioned earlier, Patterson-UTI has failed to post a meaningful profit for seven consecutive years. However, thanks to the recovery of North American oil production to record levels, the company is expected by analysts to post a modest profit per share of $0.37 this year.
Even better, the output of the U.S. and Canadian oil producers is likely to remain on the rise next year thanks to the reduced output of OPEC and Russia. This helps explain why analysts expect the company to earn $1.53 per share next year. The stock is currently trading at only 9.3 times its expected earnings in 2023. This valuation level seems cheap on the surface. However, investors should always remember the dramatic cyclicality of the oil industry. Due to this cyclicality, a price-to-earnings ratio of 9.3 is fairly reasonable for Patterson-UTI.
The risk of Patterson-UTI, which results from the high cyclicality of its business, is clearly reflected in its vast underperformance over the last decade. During this period, the stock has declined 16% whereas the S&P 500 has rallied 154%. Moreover, as mentioned above, the company is facing a major threat in the long run, namely the secular decline of fossil fuels in favor of clean energy sources. Due to this threat, Patterson-UTI is highly risky from a long-term perspective.
Upside risk
Thanks to the aggressive production cut of OPEC, which will probably provide a strong tailwind to North American drilling activity, the stock of Patterson-UTI may appreciate in the short run. In addition, if the production of oil in the U.S. and Canada continues climbing to new all-time highs for several years, despite the global shift from fossil fuels to renewable energy sources, Patterson-UTI is likely to exhibit solid business performance. In such a favorable scenario, the stock is likely to appreciate from its current level. Nevertheless, given the high cyclicality of its business and its secular headwinds, Patterson-UTI is likely to continue underperforming the S&P 500 by a wide margin in the long run, even if its stock price does not decline significantly from its current level.
Final thoughts
Patterson-UTI is likely to greatly benefit from the recently announced production cut of OPEC, as North American oil producers will almost certainly replace some of the lost barrels of OPEC. However, investors should avoid stocks that face major secular threats. Due to such threats, Patterson-UTI is risky from a long-term perspective. Its vast underperformance over the last decade and its 90% plunge between 2017 and early 2020 are testaments to the high long-term risk of this stock and its vulnerability to the downturns of the energy sector.
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