Rapid cash

Independent contract drilling: Better rigs will outweigh cash flow problems

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The ICD offers opportunities

Drilling Independence Contract (NYSE: ICD) will seek to increase share of the advanced 300-series (superspec optimal pad) rigs, which attract one of the highest daily rates in the industry and drive increased revenue by rigging. The company plans to inflate its operating margin by renewing contracts and reevaluating platform prices with existing and new customers. Platform usage is also expected to improve in 2022.

However, despite a profit margin, focusing too much on shorter-term contracts can negate the stability of long-term cash flow, as evidenced by negative free cash flow in 2021. Its leverage is not high and a debt refinancing in March will help fund an additional platform. reactivation programs. The stock is relatively undervalued compared to its peers at this level. I think the current momentum and relative valuation multiple of the stock has put it in an advantageous position for investors to consider buying the stock for a robust medium-term return.

Platform strategy and outlook

Turnover and margin

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I discussed the company’s operations and strategies in my previous article. While the supply of rigs remains limited in the United States due to years of underinvestment in anticipation of weak demand, the sudden rise in the price of crude oil has reversed the situation. During the fourth quarter, the pricing dynamic became increasingly advantageous for ICD, as evidenced by the repricing of contracts. It renewed 11 platforms during the fourth quarter, four of which were entrusted to new customers. On average, the daily rate has increased by 25%, reaching 40% in some cases. Thus, the company has revised its guidance for the first and second quarters in 2022. Management expects at least one more price increase in fiscal 2022, leading to further expansion of margins. Also, during the fourth quarter, it could increase the number of platforms under contract with cross-platform customers in a few cases.

A key driver of ICD’s expected price improvement is its potential offering of 300-series devices. The company currently has seven idle platforms in its marketed fleet. These rigs are highly rated in the industry and fetch one of the highest daily rates. In one of the recent contracts, the 300 series rigs are expected to generate margins of over $10,000 per day on an all-inclusive basis. Due to the high rate, this will reduce the ROI on platform reactivation to less than a year. He estimates that the next three platforms would cost $3 million per reactivation. Investors may note that 65% of its rigs are in West Texas and 35% in Haynesville.

The number of land rigs in the United States increased by 14% during the first quarter of 2022 compared to the fourth quarter of 2021. The price of WTI crude oil jumped by 33% during the last quarter. While completed wells increased 5%, DUC (unfinished) wells contracted 10% in the first quarter. Thus, the contract drilling industry has seen its E&P activity boosted, while the drop in the number of DUC wells signals a further shortage of supply in the coming quarters.

Main indicators and forecasts

Key indicators and forecasts

ICD filings and press release

In Q1 2022, platform operating days may increase by 8% compared to Q4 2021. Average revenue per operating day may increase by 14%, while cost per day may increase slightly , resulting in a 51% increase in the platform’s average margin per trade. day at T1. Additionally, he expects usage to increase sequentially by about 10%. In the first quarter of 2022, the company plans to operate 16.5 active platforms,

By Q2 2022, revenue growth may accelerate (20% to 23% growth from Q4) depending on contracts in place. The margin per day can almost double from here. Drivers that would see the company gain traction are pad-to-pad price revisions and its ability to pass on labor market cost inflation to its customers.

ICD management believes the industry is in the early stages of an upward cycle. Therefore, focusing on shorter-term contracts can lead to rapid improvement in margins. It also expects to achieve margins above pre-pandemic levels in the near term.

Q4 Driver Analysis

From the third quarter of 2021 to the second quarter of 2021, the company’s daily revenue increased by 11%, while the daily cost increased by 13%. Rising labor costs and year-end incentive compensation accruals drove costs higher than expected.

As of December 31, the company’s drilling backlog stood at $16.1 million, averaging significantly less than in the past. The lower backlog represents short-term pad-to-pad contracts, typically short-duration contracts compared to long-term contracts. However, given that most of the current backlog will expire by the second quarter, I believe the company will benefit from daily rate momentum in an improving market.

The current financial situation

In fiscal 2021, ICD’s cash flow from operations (or CFO) deteriorated to -$9.5 million from a slightly positive CFO a year ago. Although year-over-year revenue was up (up 5%), unfavorable changes in working capital resulted in a negative CFO. The company’s free cash flow (or FCF) also dipped into deeper negative territory in fiscal 2021. It can draw funds from the line of credit and draw funds from the debt facility at term to meet the non-operational expenses required.

ICD’s leverage ratio now stands at 0.75x, which is below the average of peers (NBR, HP, PTEN). Its liquid assets stood at $27 million as of December 31, 2021. Investors may note that although a term loan of $13 million will not be due until 2023, it will be classified as a current liability in the third quarter. , which could circumvent the company’s ability to fund the ongoing drilling reactivation program. However, in March it refinanced its term loan by issuing $157.5 million of floating rate convertible notes. The proceeds will also be used to reimburse a previous merger (Sidewinder Drilling) and future rig reactivations.

What does relative valuation involve?

Relative valuation multiples

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ICD’s current EV/Revenue multiple (2.3x) versus the contraction of the forward EV/Revenue multiple implies an increase in revenue over the next four quarters. The contraction is stronger than the average decline of its peers (NBR, HP and PTEN). This usually results in a significantly higher EV/Income multiple than its peers. However, the stock’s current EV/Revenue multiple is lower than that of its peers. Thus, it may be relatively undervalued at the current level.

Target Price and Analyst Rating

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According to data provided by Seeking Alpha, a sell-side analyst has rated ICD as a “buy” (“strong buy”) over the past 90 days. None of the analysts on the sell side rated it “Hold” or “Sell”. The consensus target price is $7.00, which would reflect returns of around 65% from the current market price.

What is the plug on the ICD?

Total returns

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In 2022, ICD is primarily looking forward to bringing a qualitative change to its operations rather than a big quantitative push. While the number of active operational rigs will grow slightly to meet higher demand, the real push will come from the increased share of more advanced 300-series rigs and the associated higher revenue per rig. form. In some cases, the renewal of contracts and the repricing of platforms with the advent of increased demand have resulted in daily rates 25 to 40% higher. As a result, its revenue and operating profit may increase significantly in the first half of 2022. With strong industrial engines and a low relative valuation, the stock should post a healthy performance in the medium term.

ICD’s growth story faces some mitigating factors. It suffers from some operational weaknesses. The company’s drilling backlog was significantly lower than in the past. Decreasing cash flow is also a pressing concern. For example, the stock has underperformed the VanEck Vectors Oil Services (OIH) ETF over the past year. Nonetheless, given the low relative valuation and current momentum, as noted above, the stock is a potential “buy”.