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Hunting weathers the storm

The specialist oil equipment and services supplier has weathered the slump in the US rig count and is now poised to grow earnings and cash-flow
December 7, 2017

In June 2015, as commodity prices approached their nardir, we commended oil equipment and services provider Hunting (HTG) for the candour of its first-quarter update. You usually only read about corporate governance ‘best practice’ when things go awry, but it’s still doubtful whether our observation that “the group never attempts to gloss over bad news” would have provided much solace for shareholders. It may have been largely academic anyway, given that the price of West Texas Intermediate (WTI) had fallen by 60 per cent peak-to-trough during the preceding 12-month period. Try glossing that one over. But times have changed.

IC TIP: Buy at 539.5p
Tip style
Value
Risk rating
High
Timescale
Medium Term
Bull points

Exposed to recovery in US onshore drilling

Low CAPE ratio

Cash flows forecast to increase

Dividend expected to be reinstated in 2018

Bear points

Oil price volatility

Margins may not reach past peaks

Two-and-a-half years later, and $57.40 will buy you a barrel of WTI crude. That represents a retracement of 119 per cent from the trough of February 2016, but the price is still $9.87 adrift of its five-year average. Hunting, along with industry peers, has had to recalibrate its expectations in the face of decimated cash margins due to the prolonged slump in prices and the subsequent fall-away in oil & gas capital budgets. That has meant cuts across the board and a refocus on more sustainable areas of the business; ergo the ongoing push to align Hunting’s businesses with the increasing activity in the onshore basins in the US. Industry conditions remain challenging, but we think that the group, unencumbered by high debt levels, is well positioned to profit from the nascent recovery in industry capital budgets.

Underlying cash profits at the half-year mark came in at $12.1m, against a loss of $29.5m in the corresponding period in 2016. What's more, while cash profit margins may never returns to the highs of the last cycle, a first-half margin at 4 per cent compared with the 19 per cent achieved in 2014 suggests substantial room for recovery. We expect to see continuing strong improvements to the top-line and cash generation through to 2020. Analysts at Canaccord envisage a modest $13m operating cash outflow through to the December year-end, before returning to a $61m inflow in the following year, then $86m in 2019 followed by $107m in 2020. Despite a prolonged deterioration in the trading environment, the group’s balance sheet remains in good trim, and Hunting is likely to return to paying dividends through 2018.  

Although the group has manufacturing facilities across the globe, the overwhelming exposure is to the US, which accounts for two-thirds of revenues, and generated the lion’s share of underlying profits at the June half-year. The group supplies to the upstream oil & gas industry, manufacturing and renting equipment through the lifecycle of a well, from construction to production. As a longstanding supplier of proprietary technologies to the US shale industry, Hunting has been at the forefront of developments linked to unconventional drilling and fracking, including the widely employed H-1 perforating gun and premium connections for drill pipes, casing and tubing used in oil & gas production.

Recent analysis from Kepler Cheuvreux identifies five main catalysts driving the Hunting business model: 1) the number of rigs in activity; 2) the number of wells drilled by rigs; 3) the average lateral length of wells; 4) the completion rate of wells drilled; and 5) the spacing between fracks. So, the health of Hunting’s income statement is inextricably bound up with onshore drilling activity. And on that score, matters are turning more favourable. On average, US well completions during the third quarter were up 47 per cent year-on-year, after similar growth in the preceding three months. The US Energy Information Administration (EIA) revealed that US crude production rose 290,000 barrels per day (bpd) in September to 9.48m bpd, approaching the high of 9.63m bpd seen in 2015. Drilling onshore in shale formations in Texas and North Dakota rose in the month, while the aforementioned research from Kepler Cheuvreux suggests that 24,600 wells will be drilled in the US in 2020 (circa 11,000 in 2016) and circa 2.4m fracks will be made in the US in 2020, a number well above 2014 levels (circa 1.3m).  

HUNTING (HTG)   
ORD PRICE:539.5pMARKET VALUE:£ 886m
TOUCH:539-540p12-MONTH HIGH / LOW:650p377p
FORWARD DIVIDEND YIELD:1.1%FORWARD PE RATIO:29
NET ASSET VALUE:660¢**NET DEBT:1%
Year toTurnoverPre-taxEarningsDividend
31 Dec($bn)profit ($m)**per share (¢)**per share (¢)
20141.4121310029.9
20150.819.03.18.0
20160.46-93.0-45.0nil
2017**0.704.01.0nil
2018**0.8359.025.58.0
% change+18+1375+2450-
NMS:3,000   
Matched Bargain Trading    
BETA:1.97   
* Includes intangible assets of $367m, or 224¢ a share. **Canaccord Genuity forecasts, adjusted PTP and EPS figures £1=$1.35