American Oil and Gas Reporter - January 2023 - 54

Outlook 2023
Creates Strong Opportunities in Oil Field
Services, " notes that oil field service
companies' earnings tend to lag those
of producers as commodity prices rise,
such that the better margins producers
enjoyed in 2022 should extend to service
providers in 2023.
Both segments' free cash flow yields
have expanded to impressive levels,
Rollyson assesses in the Raymond James
report. " As free cash flows begin to ramp
up, we note the free cash flow yields are
quite astounding relative to other sectors.
According to consensus data from FactSet,
median free cash flow yields on a next
12-month basis are ~12%. This is second
only to E&P free cash flow yields at
~13%, " he writes, adding that other industries
generally exhibit free cash flow
yields in the mid-single digits (Figure 2).
" Moreover, as the initial ramp up in
working capital starts to fade, we expect
oil field service free cash flows-and,
therefore, free cash flow yields-to increase
closer to current E&P free cash
flow yields, " Rollyson continues. " One
obvious implication from the rising free
cash flows that show up as leading yields
across other sectors is that relative valuation
multiples remain meaningfully
FIGURE 2
Free Cash Flow/Enterprise Value By Industry
14.0%
12.0%
10.0%
8.0%
6.0%
4.8%
3.9%
4.0%
2.0%
0.0%
3.4%
4.5%
4.6%
4.3%
4.4%
13.0%
12.2%
lower. If energy free cash flows are sustained
for an extended period of time-
which we believe the macro environment
suggests they will-we would presume
the valuation gap between energy and
other sectors would at least narrow versus
current levels. "
Rollyson points out that producers'
project selectiveness, a tight labor market,
supply chain snags, and capital constraints
contribute to service companies' investment
restraint. While that restraint may
make the coming upturn more gradual,
he reasons, it also points to a more lasting
one.
" Public (service) companies' focus on
returns and generating free cash flows-
in part forced on them from their E&P
customers-will likely keep a lid on new
investment in capacity relative to prior
cycles, " the report says. " We think this
should help extend the cycle, considering
it reduces the ability for U.S. oil production
to grow relative to rates over the past
couple of cycles. "
The report concludes by reiterating
that industry behavior has shifted. " The
behavior of the players in this sector
truly appears different from any time
since the mid-1990s. E&P capital discipline?
Are you kidding? Those guys
spend like drunken sailors. They borrow
on top of their cash flows to chase paper
returns! Apparently, not this time. Shareholder-forced
capital discipline during
the pandemic-era downturn and perhaps
some knowledge gained seems to have
changed the pattern.
" And this pattern appears to be rubbing
off on oil field service counterparts, " it
continues. " Can you really add incremental
equipment at the pace of prior cycles if
your customers aren't ramping spending
like they used to? Probably not. "
Improving efficiencies accompany this
capacity-constrained market, the report
observes. " For example, we will pump
more sand in 2022 than we did in 2017,
with almost 40% fewer active frac fleets, "
Rollyson calculates. " The average amount
of footage drilled per U.S. rig has doubled
since 2014, " with far fewer active rigs.
" As a result, this cycle appears to be
more about margins (see rig day rates/margins,
annualized EBITDA/frac fleet, etc.)
than volume growth like past cycles.
" Assuming our macro outlook holds,
strong margins and rational CAPEX should
drive meaningful free cash flows for oil
field service companies, " he adds. ❒
8.6%
5.3%
5.4%
Source: FactSet, Raymond James Research
54 THE AMERICAN OIL & GAS REPORTER
Real Estate
Con. Discretionary
Tech
Industrials
Healthcare
Con. Staples
Russell 3000
Telecom
Materials
Energy
OFS (NTM Consensus)
E&P 2023 (Strip)
American Oil and Gas Reporter - January 2023

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