Forum Energy Technologies (NYSE:NYSE:FET ), an oilfield services company, provides products and services to upstream companies engaged in drilling & downhole, completions, and production operations. I discussed FET's strategies and value drivers in my previous article. Currently, the company's electric line cables used in zipper and simul-frac operations and drilling product lines offering mud pump consumables are in strong demand. Much of the order growth is owed to oilfield services companies' replacement of capital components with consumable items and investment in equipment upgrades and new builds.

While cash flows were negative in 1H 2022, it recently sold inventory and assets for one of its non-core drilling products. With lower working capital requirements, it expects to generate free cash flow in 2H 2022. Although debt-to-equity is high, it can deleverage if the convertible debt-to-equity mechanism triggers (i.e., if a specific stock price is achieved). Investors can expect robust returns and may consider buying the stock.

A couple of years ago, FET's management readjusted its strategy to maintain a lean cost structure. Since then, it has been focusing on pursuing markets with a meaningful presence and can commercialize its products. Since the 2020 energy market downturn, many oilfield service companies have replaced capital components with consumable items, allowing them to keep pace with the industry. Many have invested in equipment upgrades, while others have also added new builds. As the drilling activity returned in the US, FET will seek opportunities with its portfolio of consumable and capital products.

The US onshore rig count has not changed much since Q2. The drilled well count increased by 34% year-to-date, per the EIA. On the other hand, the DUC wells decreased by 12% during this period. Overall, the energy market indicators indicate an activity rise in the US.

Through innovation in the wellbore designs, it has won new customers and gained a share in Q2. In the consumable and aftermarket items, FET will look to meet the demand completions activity demand through its wireline, conventional and greaseless cables. The electric line cables are typically used in zipper and simul-frac operations. The drilling product line offers mud pump consumables. These products, the management claims, have increased operational efficiency compared to the competitors' products.

As a result of these new offerings and increased demand in the market, FET's valve bookings grew sequentially by 26% in Q2, following a 35% increase in orders from upstream and midstream customers. Also, production equipment bookings grew by 58% from Q1 to Q2. One of its most significant orders came in the Marcellus shale. It received an order for electrostatic processing technology equipment in the Middle East. The new orders will support its 2022 revenues and improve revenue visibility in 2023.

Higher industry activity will likely impact FET's products and services demand. FET's book-to-bill ratio was 1.18x in Q2. So, with a book-to-bill ratio of more than one, the management expects its Q3 revenues to increase by 2% (at the guidance midpoint) compared to Q2. Adjusted EBITDA can inflate by 20% in Q3.

For FY2022, the management kept its annual EBITDA estimates unchanged at $50 million to $60 million, or 175% higher than in FY2021. In Q2, its incremental EBITDA margin was 38%.

Revenues increased by 7% in Q2 2022 compared to Q1 2022. Increased pricing in the drilling product line and a favorable mix drove the operating margin in Q2. Quarter-over-quarter, the segment order increased by ~5% as it received an order for two drilling catwalks from a Middle East contractor.

The revenue growth was sharp (26% up quarter-over-quarter) in Q2. Increased demand for short-cycle consumable products and improved performance resulted in better performance in this segment. Coiled tubing and wireline revenues were the primary drivers for the segment's improved performance.

This segment witnessed lower revenues (by 5%) in Q2 compared to the previous quarter. Despite that, steep growth in the order book (58% up) during this period can set the performance soaring in the rest of 2022.

The company's cash flows turned negative (-$51 million) in 1H 2022 versus a year ago. Although year-over-year revenues increased, a higher inventory and accounts receivable balance led to the cash flow decline. The management expects the net working capital to decrease in the year's second half. It has recently sold inventory and assets for one of its non-core drilling products. So, it expects free cash flow to be between $30 million and $40 million in 2H 2022 instead of negative FCF in 1H 2022.

FET's liquidity stood at $141 million as of June 30, 2022, while its debt-to-equity was 0.87x. Most of its total debt is convertible to equity at $30 a share. A conversion can increase enterprise value and significantly de-lever the balance sheet.

To understand how revenues would move in the next few years, I have developed a regression model based on the relationship between crude oil price, US completion wells, drilled wells, and FET's revenues for the past seven years. I also looked at the short-term (previous four quarters) revenues. I expect its revenues to increase by ~13% for the next two years before it declines in the NTM (or next 12 months) 2025.

I have developed a similar model for EBITDA but with a more straightforward assumption that it is based on revenues only. Based on the long-term and short-term trends, I expect the company's EBITDA to increase by nearly 200% in NTM 2023. It may decelerate and almost double in NTM 2024.

Author Created, TIKR.com, and Seeking Alpha

Author Created, TIKR.com, and Seeking Alpha

The average EV/Revenue multiple produces a 67% upside (compared to the current price) from the stock. This is higher than the returns potential using the forward EV/Revenue multiple (0.60x) (22% upside). Here, I have used EBITDA for NTM 2023 and assumed EV would remain unchanged.

FET continues to follow an asset-light, scalable base with steady operating earnings growth expectations in the medium-to-long term. In my previous article, I was reasonably optimistic about FET's outlook but stopped short of a bullish thesis, suggesting "hold." In the article, I wrote:

New rigs in Latin America and the Middle East have also led to higher international awards for the company. The stock is reasonably valued versus its peers. However, supply chain constraints can lower the operating margin expansion.

In Q2, FET's valve bookings grew sequentially by 26%, while production equipment bookings grew by 58% from Q1 to Q2. Much of the order growth is owed to oilfield services companies' replacement of capital components with consumable items and investment in equipment upgrades and new builds. This can turn the table in favor of FET swiftly. The company's cash flows can benefit immensely. So, I have confidence in a "buy" rating for the stock.

The pricing environment is getting tighter as the company's customers are pushing pricing as their demand for such services picks up. FET's order booking growth in the production equipment bookings was strong from Q1 to Q2. Its valve bookings growth was not much behind during this period. The drilling fluid end module and the valve product line may continue to see net pricing gains. However, the pricing is still below the 2019-level.

The stock performed nearly in line with the VanEck Vectors Oil Services ETF (OIH) in the past year. Although cash flows were negative in 1H 2022, the management expects to turn it around through lower working capital requirements and inventory sales. Although debt-to-equity is high, it has sufficient liquidity that makes its balance sheet healthy. Given the return potential from the changes in the relative valuation multiples, you may consider buying the stock at this level.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.