Precision Drilling Part 2: Estimates And Relative Valuations

Our regression estimates suggest a 5% revenue growth in NTM 2023, but the rate can accelerate (26%) in NTM 2024
The EBITDA growth rate is ~25% in each of NTM 2023 and NTM 2024
The relative valuation suggests the stock is marginally undervalued, although our regression model suggests a potential downside at this level

Part 1 of this article discussed Precision Drilling Corporation’s (PDS) outlook, performance, and financial condition. In this part, we will discuss more.

Linear Regression Based Forecast

Based on a regression equation on the relationship between the crude oil price, the US rig count, the Canadian rig count, and PDS’s reported revenues for the past seven years and the previous four quarters, I expect revenues to increase by 5% in the next 12 months (or NTM 2023) and 26% in NTM 2024 (sequentially).

Based on a simple regression model using the average forecast revenues, the company’s EBITDA can improve by 25% and 23% in the next two years.

Relative Valuation Analysis

PDS’s forward EV-to-EBITDA multiple contraction versus the current EV/EBITDA is steeper than its peers because its EBITDA is expected to increase more sharply than its peers in the next four quarters. This would typically reflect a higher EV/EBITDA multiple than its peers. The stock’s EV/EBITDA multiple (11.7x) is in line with its peers’ (HP, NBR, and PTEN) average of 12.1x. So, the stock is relatively undervalued at the current level.

EV has been calculated using PDS’s EV/EBITDA multiple. The returns potential using the forward EV/EBITDA multiple (9.4x), using our regression model-derived EBITDA, is lower (27% downside) than sell-side analysts’ expected returns (43% upside) from the stock.

What’s The Take On PDS?

As drilling activity in Canada rises, the leading-edge rates are trending up. PDS’s rig upgrade programs are backed by take-or-pay contracts, ensuring a steady return on investment. Over two-thirds of its Superior Triple rigs drilling in multi-well pads have adopted Alpha Automation and Alpha Apps, which command a premium over the industry rate. On top of that, the addition of Alpha Analytics and managed pressure drilling support can take it even higher. In the current favorable environment, its operating margin per rig to increase by ~40% in Q3. As a result, the stock outperformed the VanEck Vectors Oil Services ETF (OIH) in the past year.

However, the company’s policy to stick to profitable-only projects can lead to project rejection where customers are unwilling to increase prices or do not accept take-or-pay contracts. Its balance sheet is leveraged. In 1H, PDS’s free cash flows turned negative. Hence, a cash flow paucity can put a question mark on its lofty deleveraging target. The stock is relatively undervalued with a marginal positive bias. I expect returns from the stock to improve moderately in the medium to long term.