RichVintage/E+ via Getty Images

RichVintage/E+ via Getty Images

It hasn't happened yet, but it might. As I and a bunch of other authors have been noting in recent articles, shale production has been maintained by DUC withdrawal. There will be an end point to that... fairly soon. What happens then is anybody's guess, but if we are to maintain, output drilling must increase. We will have the December issue of the EIA-Drilling Productivity Report out soon and I expect it will show another significant decline in DUCs.

It's been a while since there was reason for some optimism in the drilling segment of the Oilfield Service Sector. To be clear, I don't think they are going to burn like a Roman candle, but better days could be ahead.

If this turns out to be correct, then Nabors Industries (NYSE:NBR ) could be one of the earliest beneficiaries of a move away from relying mostly on DUC withdrawal to drilling new wells. As you can see, it's built strength from early December toward $100, which it's reached twice since then. Momentum collapsed with the release of the Fed minutes today, but we don't think that impairs the pivot story. Rather fretting about missing the absolute bottom, let's recognize that it still has quite a ways to go before breaching those three tops in the $120s. If we were a part of that, there shouldn't be any complaints. And as you can see, when it moves, it moves fast.

Note: this article appeared mid-December in the Daily Drilling Report.

The company is a premier purveyor of high spec rigs, mostly on the land side - it does have some platform rigs for offshore that are in high demand now. In fact, that's all anyone wants as the efficiencies these PaceSetter rigs bring cut days off drilling costs. The baggage that NBR brings is the large number of older low spec rigs that can't be marketed at any price. Of course, and the legacy debt that comes with them.

The company is repairing its balance sheet and has grown free cash substantially in Q-3 over Q-2, and expects further improvement as they are now able to move pricing higher. We will discuss this further in the quarterly review.

Nabors has a couple of catalysts that should propel earnings higher in the growth rig environment that we project is coming. The first is the SANAD work in Saudi. That is high margin work that will contribute $10 mm of EBITDA per rig, and could lead to as many as 50 rig-awards over the next 10 years. The second is Nabors Drilling Services, a software suite marketed to lower tech drilling contractors. This business has grown and seems to be gaining market share in this area of rig services.

Revenues were up 7% QoQ to $524 mm with all segments contributing to the gain. The company booked a loss for the quarter of $122 mm largely due to an $81 mm write-down on the sale of its Canadian rigs. Rig Technologies and Drilling Solutions revenues were up 22% and 17% respectively. Free cash flow rose to $133 mm (adjusted) after the sale of the Canadian rigs. This compared to $68 mm for Q-2. Forecasts are for FCF to be in the range of $80-90 mm for Q-4.

The company carries $2.3 bn of long-term debt, but has steadily reduced that figure by $120 mm from Q-2. Since early 2020, long-term debt is down from $2.9 bn. The company has $585 mm on an RCA that's due in 2023 that will need renegotiation, as the cash isn't there yet to repay it. Capex for 2021 is expected to be $270 mm, but that figure includes about $90 mm which is funded by SANAD for new rig building.

Generally, pricing is increasing for the Super-spec rigs, but labor and supply costs are a challenge for them to maintain and improve rig margins.

Anthony Petrello, CEO of NBR comments on the pricing environment he sees going to into 2022:

Our rates now are solidly in the $20,000 environment. Before the second quarter, it was kind of hard to get above $20,000. Now the latest contracts, we're asking customers for $22,000 and are not flinching. So I think the environment has changed. It's changed materially, and it's changed in the favor of the drilling contractors.

The company averaged 70 Super-spec rigs in the third quarter and expects this to improve to 80 in Q-4. International growth is forecast to rise into the mid-70s in Q-4.

The SANAD deal is a strong base for continued international growth. Most of the key financials are outlined in the slide below. Saudi needs to drill to maintain its swing producer position and has previously stated it wants to be able to deliver 12-13 mm BOPD. Only new field discoveries will get it there.

Anthony Petrello comments on the international growth story and the SANAD opportunity in particular:

And plus the newbuild starts and the illustration of that potential activity is that with the newbuilds in 2022, that should add about $20 million of EBITDA on top of the $75 million run rate roughly in the last quarter, the $300 million. That's a pretty healthy increase. And by the first quarter of 2023 that number is about $50 million. So it's almost a 17% increase in that market alone. And by the following year, when you have additional rigs hitting the market in 2023, that goes up a bit roughly $70 million. So you have extraordinary double-digit growth there on top of the other markets we talked about. That's why we think international - our position internationally, I think, is actually second to none right now and the visibly is pretty clear.

I think NBR has made a smart decision to market its Drilling Solutions software outside to third-party drillers. They can't get every contract, and if the software is used on another company's rig, it's revenue they wouldn't otherwise get. This seems to be a successful strategy as they report sharply increasing growth in this business. I described the applications here in another article, so please have a look if you want more detail here.

Drilling Solutions EBITDA of $15.6 million was up $2.8 million or 22% in the third quarter. Combined Rig and Drilling Solutions daily gross margin rose to $8,900. This translates into a $1,900 per day contribution from this rapidly growing solutions segment. Increased EBITDA is forecast for Q-4.

Let's be clear, putting money into the drillers is a risky bet. Their beta with oil prices is extremely high as they have nothing to sell if no one's making holes. That makes the entry point all important. There is really no financial Kung Fu to do with NBR's balance sheet, but we can have some fun with the numbers for rigs projected in the Oil Trends Tracker article.

Nabors has a flakey debt-loaded balance sheet - it's a driller after all, but faces no near-term liquidity crisis in the present environment. It sees improving margins and has several catalysts that separate it from competitors.

With 576 rigs chewing up dirt presently, NBR with 72 of them has a 12.5% market share. If another 250 rigs go back to work, that's another 25-28 rigs in their tally book. At day rates of $22K and rig margin in the neighborhood of $15K, taking an average of 16, that's about another $80 mm of EBITDA. Add that to this year's adjusted EBITDA of $350 mm and you have $430 mm, or about a 20% improvement. Currently, they are selling for 8.76x adjusted EBITDA. Add 20% to their present $767 mm capitalization and you get $920 mm and you get a share price of $112. Momentum could carry it considerably beyond that as it has several times since the reverse split. $150 isn't out of the question in the scenario. It achieved that in early 2020.

If your risk profile includes a high-risk, high-reward proposition such as the one presented by NBR, I would suggest that a solid move below $90 might be appropriate. Something in the $80s. Most of last year, as the industry has gradually picked up rigs, the stock has been above that point. Given the environment we expect for this year, that should prove to be a pretty safe entry point.

I will close as I began. DUCs have carried the freight for shale production over the last year and half. There is a balance point in DUC inventories that is ~4,000 wells nearer than it was. Shale doesn't ooze out of the ground. It has to be fracked, and to get there... someone has to eventually drill a well.

This article was written by

I am an oilfield veteran of 38+ years. Retired from Schlumberger since 2015. My background is drilling and completion fluids. I have authored a number of technical papers on completion topics. I have worked around the world- Brazil, Russia, Scotland, and the Far East. I still maintain a training and consulting practice and am always willing to help people who want to learn.

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Disclosure: I/we have a beneficial long position in the shares of NBR either through stock ownership, options, or other derivatives. 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.

Additional disclosure: This is not advice to buy or sell this stock or ETF. I am not an accountant or CPA or CFA. This article is intended to provide information to interested parties and is in no way a recommendation to buy or sell the securities mentioned. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to do their own due diligence before investing their hard-earned cash.