The Oil & Gas Equipment & Services sub-industry kicked off the 21Q4 earnings season for the S&P 500 Energy sector.

We take a closer look at this sub-industry as it can be viewed as a leading indicator as to how the larger Exploration & Production sub-industry performs in the coming weeks. The Energy sector will be a key focus this quarter as highlighted in a previous post (S&P 500 21Q4 Preview: Another Quarter of Double-Digit Growth on Tap, January 11, 2022), where we highlight that the sector is currently expected to contribute 8.12 percentage points (ppt) to the overall 21Q4 index growth rate of 24.1%, which is equivalent to a third of the overall contribution from an earnings perspective.

Exhibit 1 highlights 21Q4 results for the Oil & Gas Equipment & Services sub-industry. Schlumberger NV SLB and Haliburton Co HAL beat analyst expectations, posting earnings of $0.41 and $0.36 respectively, which was 5.4% and 5.8% above analyst expectations.

Exhibit 1: 20Q1 Results for S&P 500 Oil & Gas Equipment Services

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For Haliburton, this marks the 14^th quarter in a row where the company has posted a positive earnings surprise which is an impressive feat. Schlumberger NV is not far behind, posting a positive earnings surprise for the 11^th consecutive quarter.

All three constituents in the sub-industry beat analyst expectations on the top-line with Haliburton Co and Schlumberger NV posting year-over-year growth (YoY) of 32.1% and 12.5% respectively.

Looking ahead, the sub-industry is forecasted to post year-over-year earnings growth of 62.6% in 2022 on an aggregated basis and revenue growth of 13.3%.In comparison, the overall Energy sector is currently forecasted to post 2022 earnings and revenue growth of 31.3% and 8.4% respectively.

A multi-year growth cycle on the way

While a small sub-industry in terms of number of constituents, all three companies provided a bullish outlook on the macro environment and an improved supply/demand picture. Looking at Refinitiv Workspace, we highlight specific commentary from earnings call transcripts below:

• “Looking ahead, we have increased confidence in our view of robust multiyear market growth. Tight oil supply and demand growth beyond the pre-pandemic peak, are projected to result in a substantial step up in capital spending amid shrinking spare capacity, declining inventory balance, and supportive oil prices” (Source: 21Q4 Earnings Conference – Schlumberger NV).
• “I expect the macro industry environment to remain supportive. And as we saw in 2021, the international and North America markets will continue their simultaneous growth. This is momentum that I have not seen in a long time … There is no doubt the much-anticipated, multiyear upcycle is now underway.” (Source: 21Q4 Earnings Conference – Haliburton Co).
• “We believe the continuing broader macro recovery will translate into rising energy demand in 2022 with oil demand likely recovering to pre-pandemic levels by the end of the year. Pairing this demand scenario with continued OPEC+, IOC and E&P spending discipline, we expect the oil markets to remain tight for some time” (Source: 21Q4 Earnings Conference – Baker Hughes Co).

An improvement in exploration activity significantly benefits the equipment services industry, which supplies drillers with value-add services and equipment. One measure of exploration activity is looking at the number of land-based rigs in the United States which are used by oil producers.

As per Exhibit 2, the current rig count reading is 491, up 71.1% YoY and steadily improving towards pre-pandemic levels of approximately 700.

Exhibit 2: U.S. Rig Count

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Improving EBITDA and FCF margins

As companies aggressively cut costs during the pandemic combined with a recovery in oil prices over the last 22 months, we see an improvement in operating margins across the sub-industry.

Schlumberger NV posted a 21Q4 EBITDA margin of 22.2% which is the sixth consecutive quarter of margin improvement (20Q2 EBITDA margin was 14.0%). The company has provided guidance of reaching a 25% EBITDA margin by the end of 2023.

Exhibit 3 looks at the annual EBITDA margin for all three companies in the sub-industry since 2003 using the excel add-in for Refinitiv Workspace. Looking at Schlumberger NV, Refinitiv I/B/E/S estimates forecast a consensus 2023 EBITDA margin of 24.3%.

Haliburton Co has a forecasted 2023 EBITDA margin of 20.6%, while Baker Hughes Co BKR is forecasted at 15.9%, both of which are above the historical 10-year average of 18.2% and 13.0% respectively.

Exhibit 3: EBITDA Margin

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A similar picture is seen for free-cash-flow (FCF) margins. As shown in Exhibit 4, Schlumberger NV has the highest FCF margin out of the group, with a forecast 2022 FCF margin of 12.0%, followed by Haliburton Co (7.8%), and Baker Hughes Co (7.1%).FCF margin expectations through 2024 are expected to increase for all three constituents, highlighting the disciplined shareholder approach that most companies in the sector have been adopting.

Exhibit 4: Free Cash Flow Margin

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As a percentage of market cap, FCF yield is also expected to improve for all three companies. Schlumberger NV has an I/B/E/S consensus FCF yield of 5.8% and is expected to improve to 8.4% by 2024. Similarly, Haliburton Co’s FCF yield is expected to improve from 5.1% to 8.6% over the same period.

With higher free cash flow, Haliburton Co is using this money to redeem $600 million of det maturing in 2025 which currently sits at $1 billion. Once completed, Haliburton Co will have one of the lowest short-term debt loads of the group (defined as total debt obligations up to 2025).

By using Refinitiv Workspace, we can look at the debt structure by trying “Debt Structure” in the toolbar. Haliburton will have approximately $1.2 billion in debt obligations (once $600m of 2025 debt is redeemed) as shown in Exhibit 5.

Exhibit 5: Haliburton Debt Structure

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Many of the large oil drillers begin to report 21Q4 earnings and we may have already seen a preview of what’s to come.