PRECISION DRILLING Corp Q1 FY2023 Earnings Call

Thank you, operator. Welcome everyone to Precision Drilling's First Quarter Earnings Conference Call and Webcast. Today, I'm joined by Kevin Neveu, our President and CEO; and Carey Ford, our CFO. Earlier this morning, Precision reported strong first quarter results. Carey will review these results with you, followed by an operational update and outlook commentary from Kevin. Once we have finished our prepared comments, we will open the call to questions. Please note that some of our comments today will refer to non-IFRS financial measures, and will include forward-looking statements, which are subject to a number of risks and uncertainties. For more information on financial measures, forward-looking statements and risk factors, please refer to our news release and other regulatory filings. As a reminder, we express our financial results in Canadian dollars unless otherwise indicated. With that, I'll turn it over to Carey.

Thanks, Lavonne. Precision’s Q1 financial results exceeded our expectations for revenue, adjusted EBITDA, earnings and cash flow. Adjusted EBITDA of $203 million was driven by strong drilling activity, improved pricing and strict cost control. Our Q1 adjusted EBITDA included a share-based compensation recovery of $12 million, which reflects our stock price decline during the quarter. Without this recovery, adjusted EBITDA would've been $191 million, which compares to $84 million in Q1 2022, an increase of 127%. Revenue for the quarter was $559 million, an increase of 59% from Q1 2022. Margins in both the U.S. and Canada were higher than guidance, resulting from stronger than expected pricing, higher ancillary service revenue, and improved cost performance. I commend our marketing and operations teams for achieving these results. In the U.S., drilling activity for Precision averaged 60 rigs in Q1, consistent with our activity in the previous quarter. Daily operating margins in Q1, excluding the impacts of turnkey and IBC were US$14,179, an increase of US$2,330 from Q4. For Q2, we expect normalized margins to be relatively flat with Q1. In Canada, drilling activity for Precision averaged 69 rigs, an increase of six rigs or 9% from Q1 2022. Daily operating margins for the quarter were $13,558, an increase of $1,210 from Q4 2022. For Q2, our daily operating margins are expected to be approximately $10,000, down from Q1 due to normal seasonality and lower fixed cost absorption. Internationally, drilling activity for Precision in the current quarter averaged five rigs. International average day rates were US$51,753, an increase of 3% from the prior year. In our C&P segment, adjusted EBITDA this quarter was $17.4 million, up 166% compared to the prior year quarter. Adjusted EBITDA was positively impacted by a 53% increase in well service hours and improved pricing, reflecting improved industry activity and higher demand for our services. Well abandonment work represented approximately 30% of well servicing operating hours in the quarter. In addition to strong performance by our well servicing operations, our rentals and camps divisions approximately doubled EBITDA contribution from Q1 last year. Capital expenditures for the quarter were $51 million, which included $16 million for upgrade and expansion and $35 million for maintenance. Our full year 2023 capital plan has decreased by $40 million, and the new $195 million plan is comprised of $146 million for sustaining infrastructure and $49 million for upgrade and expansion. The decrease in planned capital spending reflects our focus on capital discipline and cost control and includes fewer expected rig upgrades, long lead maintenance deferrals, and lower inflation estimates. As of April 25th, we had an average of 63 contracts in hand for the second quarter and an average of 55 contracts for the full year 2022. Moving to the balance sheet, our Q1 results reflect the seasonal working capital build within our business and one-time payments highlighted in our press release. During the quarter, we drew approximately $80 million on our revolver and built our cash balance by $20 million. The cash used during the quarter was less than expected due to strong in-the-quarter collections and completed asset sales. As we have lower seasonal activity in Canada during the second quarter and no semi-annual interest payment, cash is coming in the door and we expect to have paid down the $80 million revolver draw by the end of the second quarter, and will concentrate our annual debt reduction in the second half of the year, similar to last year. As of March 31st, our long-term debt position net of cash was approximately $1.1 billion, and our total liquidity position was $540 million, excluding letters of credit. Our net debt to trailing 12 month EBITDA ratio is approximately 2.4x down from 6.7x last year, and our average cost of debt is 7%. We expect our net debt to adjusted EBITDA before share-based compensation expense to be approximately 1.25x to 1.5x by year end. During the quarter, we utilized $5 million to repurchase shares. We remain committed to reducing debt by over $500 million between 2022 and 2025, and achieving the normalized leverage of 1x or below. Our net debt reduction target for 2023 is $150 million, and we plan to allocate 10% to 20% of free cash flow before principal payments directly to shareholders. Moving on to guidance for 2023, depreciation is the same at $285 million and SG&A remains the same at $90 million before share-based compensation expense. We expect cash interest expense to be approximately $80 million for the year and cash taxes to remain low with an effective tax rate of approximately 25%. Also, for 2023, we expect share-based compensation expense to range between $20 million and $40 million for the share price range between $60 and $100. The annual share-based compensation accrual could increase or decrease another $15 million based on relative share price performance, and a multiple between zero and 2x. With that, I'll now turn the call over to Kevin.

Thank you, Carey. We're very pleased with the strong start to 2023. The momentum we established last year is continuing well into this year and our long-term outlook remains unchanged. Our market positioning with our fleet of Super Series rigs, combined with our AlphaAutomation technology and EverGreen solutions, along with the strong long-term energy fundamentals and Precision's broad geographic exposure, gives us confidence in our plans for this year and the future. This geographic exposure is crucial since weakness in one region can be offset by strength in others. I will begin with our international operations in Kuwait and Saudi Arabia. Recently, we re-contracted seven rigs in the region on five-year contracts, including reactivating two previously idle rigs. We anticipated some rig downtime as we worked through the recertification process on four of those rigs before beginning the new terms. The first of those rigs was back in operation in early April, about a month earlier than planned, as our team successfully expedited the recertification process. We expect the remaining three rigs to follow a similar expedited path, with reactivation occurring over the next 12 to 15 weeks. By the third quarter, we will have eight rigs operating, up from five today and six last year. We see continued opportunities and have already bid on our last idle rig in Kuwait, which we expect could be active late this year or early next year. This leaves us with one idle rig in Saudi Arabia and three others in the region, but we will continue to market them throughout the Gulf region as several countries are beginning to seek increased drilling activity. Now turning to Canada. This region may receive less attention from capital markets than the U.S. land industry, but for Precision, Canada remains a critical focus. We are experiencing strong customer demand fueled by the upcoming completions of the Trans Mountain oil pipeline expansion and the Coastal GasLink pipeline for LNG Canada. Demand has been further boosted by a recent settlement in British Columbia with the Blueberry First Nation, which is facilitating oil and gas licensing approvals, leading to increased demand for our fully booked fleet of Super Triple rigs. In Canada, during the first quarter, we averaged 69 active rigs with a peak of 79 rigs, which is 9% higher than last year. Throughout the first quarter, we observed customer interest for an additional 5 to 7 Super Triples beyond the 29 we currently have in our fleet, and this demand surged after the First Nation settlement. The strong customer signals remain consistent today, with our team addressing multiple inquiries for Super Triple rigs for post breakup and into 2024 drilling programs. Looking ahead to 2024 and beyond, with LNG Canada expected to start in 2025, we anticipate continued growth in Super Triple demand, which is echoed by our customers who are considering multi-year take-or-pay contracts for Super Triple rigs for extended drilling programs. This contract structure was traditionally only associated with new build rigs in Canada, indicating strong customer concern regarding rig availability in the near and distant future. We have the capability to move additional ST 1200 rigs from the U.S. to Canada, but we would require customers to cover the full mobilization costs, along with day rates comparable to those in the U.S., which would place those rates in the upper 30s compared to our current fleet averages in the low 30s. Furthermore, Precision's Super Single rigs are seeing the highest demand since 2014. During the winter season, we operated 43 Super Singles and even now, as we navigate through the spring breakup, all our pad-equipped Super Singles are actively drilling for conventional heavy oil. This resurgence in heavy oil drilling is largely due to the significantly narrowed WCS discount and a strong U.S. dollar motivating our customers to return to drilling. The Precision Super Single rig was the first high-efficiency pad rig introduced by the company in the 1990s. These rigs are low operating cost, highly efficient, and mobile, maintaining the leading market share in all Canadian heavy oil drilling applications, including SEG-D, conventional heavy oilsands, and the Clearwater play. As we engage with customers to outline their plans for summer and fall drilling programs, we see continued strong demand for Super Singles for the rest of 2023, with some customers already looking to secure access for the winter of 2024. With the additional oil takeaway capacity from the soon-to-be-commissioned Trans Mountain oil pipeline, we are confident that this rig demand will be sustained over the long term. Our sales team is currently booking rigs for summer activities, negotiating long-term contracts in the Montney region, and scheduling rigs for next winter. These discussions are crucial, especially considering customers' concerns about service cost inflation and rising prices. It's important to emphasize that our rigs are currently drilling wells in Canada with significantly higher safety and speed than during the previous cycle in 2014. To maintain our high performance and deliver enhanced levels of safety, drilling pace, and operational excellence, we need to achieve financial returns above our cost of capital. We are not there yet, but we will continue our efforts to control costs while also working to improve day rates. This necessitates close collaboration and effective communication with our customers, as well as a shared perspective on the overall success of the industry. Currently, we are operating 38 rigs, which is approximately 15% higher than this time last year, aligning with first quarter activity increases from last year, and we expect this trend to continue throughout 2023 for Precision in Canada. Regarding our well service business, as Carey mentioned, it performed very well in the first quarter with strong utilization and improved pricing. Similar to our drilling business, we recognize that our customers are sensitive to rate increases and service cost inflation. I want to highlight Precision's strong focus on safety, reflected in the excellent results our well service team has achieved. We face significant challenges in recruiting, training, and retaining crews, which is crucial given the nature of the well service business. These challenges require skilled management teams supported by comprehensive recruiting, training, and safety programs. We also have to manage the considerable rise in rig maintenance, repair, and service certification costs. None of this is inexpensive in 2023, but you can see the scale benefits in Precision demonstrated by the smooth integration of the High Arctic acquisition over recent months. After the spring breakup, we expect strong customer demand to continue through the end of this year and into mid-2024 in our well service segment. Now, regarding the lower 48, the leading edge rates we discussed last quarter continue to impact contract renewals, and industry peer pricing discipline remains a significant market factor, even as we notice a softening in natural gas activity due to declining prices. With stable oil prices, we anticipate oil-directed drilling to compensate somewhat for the decline in gas activity, though this may take time. In the long term, as LNG exports ramp up later this year and into next year, we foresee a significant increase in demand for both oil and gas-directed drilling. Our long-term outlook remains positive. Currently, we are running 57 rigs in the U.S., with only a slight decrease from Q1. Although we have experienced some rig churn due to re-contracting, well-to-well renewals, and migration to new operators, I am pleased with the performance results from our team so far. Notably, our net rig activity in the Hayesville and Marcellus is actually up one rig from earlier this year, which suggests our customers are seeking out the best performing rigs, particularly those equipped with Precision's Super Triples and AlphaAutomation. While our sales team has performed admirably, I do not expect this activity level to remain steady through the second quarter. It is challenging to predict an exit level for Precision's Q2 activity, but I believe we will maintain at least low 50s activity levels. As previously mentioned, oil-directed demand remains firm, and we have several contracted rigs for oil-based projects scheduled to start in the second half, all progressing as planned. Bidding activity is exceptionally robust, with 58 specific rig bids in just the past 30 days and 109 outstanding bids for Super Triple rigs, all with potential start dates ranging from July through the first quarter of 2024. The volume of bids and customer inquiries aligns with previously observed data points and continues to be strong indicators of solid customer interest in high-spec rigs. We will closely monitor the dynamics in the U.S. market, and while we expect there may be near-term pressure on rig activity, we remain disciplined with our rig pricing expectations while also focusing on maximizing cash flow from our operations. Regarding our EverGreen solutions product line and AlphaAutomation services, I want to highlight our equity investment in CleanDesign, our battery energy storage partner. We see our battery energy storage systems as a key strategy for reducing rig emissions. Our equity investment in CleanDesign is critical for supporting their growth while also providing Precision an opportunity to benefit from the wider adoption of their solutions, both in and beyond the oil and gas sector. Recent announcements also indicate strong customer support for the value created by AlphaAutomation through enhanced drilling efficiency, as well as the value EverGreen offers in reducing rig emissions and fuel costs. These product lines are fundamental components of our competitive strategy, enabling growth while addressing emission-related risks. To conclude, I want to briefly discuss our business model. Precision Drilling was established and honed in the Canadian market, where seasonal fluctuations and ongoing natural gas uncertainties were standard conditions for much of our history. Our business model is designed to control what we can manage, including safety, rig performance, variable and fixed costs, capital expenditures, and staffing, while consistently delivering free cash flow through our highly variable cost structure. Short-term industry cycles do not detract from our business model or annual priorities. We have consistently demonstrated our ability to achieve our goals regardless of market conditions, including cash flow and debt reduction targets, which we have met or exceeded consistently, even during the industry downturn of 2020 and 2021. I assure you that we will confidently meet our objectives for 2023, despite the anticipated weaker natural gas outlook that was predicted at the beginning of the year. Thank you to the people of Precision for their efforts and the achievements they continue to make by managing elements of the business that each of you can influence. I also want to thank our investors for their patience and support. I will now turn the call over to our operator for questions.

Our first question comes from Waqar Syed with ATB.

Kevin, could you elaborate on the current rate environment and share your insights regarding rig release notices? One of your competitors mentioned that rig release notices were quite high in early March but have since decreased significantly. Are you observing a similar trend?

Waqar, good questions. It's really hard to glean out any trend from rig releases. I will tell you that we have seen kind of repeatedly over the last few quarters that our customers will tend to make decisions near a quarter end or before a reporting period so that they can report that they've already completed whatever work they wanted to do. So, it's common that at the end of a quarter or early in the next quarter before an earnings call, that if they plan to lay a rig down or two, they do it before their earnings call, so they can say the work is already done. So there's usually a little bit of an increase in activity around quarter end, beginning of the next quarter. That's not uncommon. We've seen a bit of that this quarter but we also saw previous quarters. Just speaking to day rates and what we see for rate activity. It depends a little bit on just how competitive the environment is. If we're in an area where we're kind of the only rig around and mobilization costs for other rigs tends to be higher, then we're much closer to those leading edge rates. We might have quoted even back on our Q4 conference call. If we're in an area where there tends to be maybe three or four rigs competing for the same job, then yes, rates are going to be a little softer. We are expecting to see rates kind of pull back a little bit in those peaks of Q1, I'd say in that range of $3,000 to $4,000 to $5,000.

Okay. So leading edge is in the gas business, could be in that low 30s to mid-30s kind of level, is that fair?

I think that's reasonable. We have been kind of lucky so far in that. We have been activating rigs and customers have been seeking out our AlphaAutomation. So, so far, so good. But going forward, I do expect it to be a little bumpier, and we could see competition in that mid-30s or low-30s range. I think that's possible.

Okay. And then on the cost, OpEx side, is that kind of holding firm or what trends are you seeing there?

Hi, Waqar. So we have had a little bit of a labor increase in the fourth quarter that was highlighted in our press release. But other than that, the costs are firm. We are not really seeing any inflationary impacts on a sequential basis, and we could actually see some inflationary relief here in the coming quarters.

Okay. And on the Canadian side like as you are negotiating your contracts now, do you see rates headed higher for H2? Or is it mostly going to be first quarter next year when you see the new rates?

We have about two pricing cycles in Canada. One cycle starts in Q3, and the second begins in Q1 of the following year. I expect there will be some opportunity for prices to increase in Q3. Those negotiations are currently underway. I provided detailed information in my prepared comments regarding the cost pressures we are facing and the need to achieve a return on capital that exceeds our cost of capital. I am aware that these discussions are happening, and our customers are very price-sensitive at the moment. However, to maintain this level of performance, higher rates are necessary. We will continue to apply pressure in the market and ensure that our rigs deliver outstanding results for our customers in terms of safety, performance, and predictability.

Our next question comes from Cole Pereira with Stifel. Your line is open.

For the U.S. rigs that were dropped, was this a function of customers just laying down rigs, or was it maybe a little bit of you losing the rigs because you wanted to stay firm on price as well?

The simple answer to that question is, yes. We have had a bit of both. And as I've said in previous calls Cole, the best signal we can send our customers about discipline is by rejecting prices that are below our threshold. And I'd kind of further that comment by saying, I think it's fair to say that a few customers out there are looking at this period right now as a chance to grab a premium rig and maybe get a discount price, we are not going to let that happen.

Got it. Thanks. And you talked about a rig count in the low 50s in the U.S. Should we be thinking that your rig count stabilizes at that level for the rest of the year? Or can it maybe climb or fall further in the second half potentially?

Yes. So it's all going to ultimately depend on commodity prices. I think we have seen the gas price bottom out here around $2. And if the oil prices firm up, we think a lot of those rigs that are getting laid down in the gas basins will get picked up in the oil basins. So I think we've got good visibility here for the next few months. And then beyond that, it's going to be largely a function of where commodity prices are.

I understand that you typically do not provide margin guidance for more than one quarter. However, given that the U.S. rig count is in the low 50s, it seems reasonable to expect that drilling margins should remain similar, though they may fluctuate somewhat.

Yes, I think with stable activity we should be able to maintain similar margins.

And in Canada, I mean, you talked a little bit about pricing and so on and so forth. Can you kind of talk about your visibility right now for Q3, Q4 activity relative to Q1 from what you see today?

Yes, sure can. Last couple of years we've been able to actually exceed Q1 activity peaks in third or fourth quarter. I don't think that happens this year, but a couple of notable features about Q1 that I think do speak to the rest of the year. I think we said our peak was 79 rigs and our average was 69 rigs. To have a 69 rig average and only a 79 rig peak over the entire quarter is quite remarkable. Spring breakup came quite late. Activities stayed quite long because customers kept rigs working as long as they could. And there's a definite focus to level load. So I do expect that our Super Triples, once they fire back up again, once they're all fired up, they stay active for the rest of the year. Whether they fire up on May 15th or April 29th or June 5th, that activity stays flat for the rest of the year. Probably a similar situation with our Super Singles. I think the variability will be on our doubles. So I think we'll see good loading levels that start early and get to levels in that 60 plus rig range in July and then hold there for the rest of the year. Very stable loading. Our customers are focused on trying to minimize variability in this market. It's a real industrial based market now and that plays well into our model.

And Carey on the credit facility side, and once you repay the Q1 draw, you don't have much of a balance there to get through? Once you get through that, I mean, is the plan sort of to eventually call your next tranche of bonds and maybe put all or a portion of those on the credit facility?

So, you're correct. We've got about CAD60 million left on the credit facility based on our guidance for what we're going to do in Q2. So to hit CAD150 million target, it'll require us to pay down that balance on the credit facility. And then about another CAD90 million high yield bonds. Those 26 notes are callable at the end of the year. So we'll look to likely use that for some of our debt reduction. And then if we look at where interest rates are right now, there's not a whole lot of difference between the coupon on those 26 notes or the 29 notes and what we're paying on a revolver. So there's not a big benefit to calling those bonds and putting them on the revolver right now.

Our next question comes from Luke Lemoine with Piper Sandler.

Kevin, you talked about some possible oil project startups in the second half. Could you maybe kind of give us the order of magnitude that you're expecting there?

We have a contract to be signed early in the year for reactivations in Q3 and Q4. And those are proceeding and we worked with our customers on that and there's been no change in their sentiment. And those would have been rates that were negotiated back in early Q1.

And then on the CapEx, you gave us the dollar amount of how much of upgrade CapEx is coming down, but could you talk about maybe how many rigs you are planning to upgrade and what those upgrade plans were that you pulled out?

Sure. We can. It was an amount of money that would be targeting some additional technology upgrades, which we may slow down on, depending on market demand on additional rigs. We are targeting some third-pump mud generator packages that if the rig count doesn't get above 62 or 63, we probably don't need those upgrades. But if we get back to 62 or 63 rigs, we could bring that capital back into play. So it depends heavily on, like Carey said earlier, commodity prices and market conditions.

And there were no major upgrades contemplated in that budget.

Okay. Got it. Um, I appreciate…

When the budget was created, we aimed for an increase of about 50 rigs industry-wide. However, since we have removed that target of 50 rigs from consideration, our share, which could have been four, five, or six rigs worth of upgrades, has also been excluded from our capital plans.

Our next question comes from Keith MacKey with RBC.

Maybe just if we could start in Canada, just wanted to ask about what you're seeing in heavy oil, particularly the Clearwater as far as the demand for rig spec. Has that changed at all in the last call it one to two quarters, given some changes in how operators in the Clearwater are drilling wells or have things and have demand remained relatively stable for the type of rig that is most desired in the Clearwater?

Yes. Really, truly a great question. The Clearwater is still early days in its development, early really a couple of years into it right now, and they're still experimenting with the length of the laterals and the number of laterals off each wellbore. So, it's a great question. The wellbore configurations are evolving with time and we're keeping pace with that. And nothing right now that's changing, that's impacting our rig capability. I do expect the torque requirements to go up and we may need to boost the torque on some of our Super Singles. That's a pretty minor upgrade.

Okay. Got it. Thanks for that. Maybe just regarding the rig count in the U.S. being in the low 50s for Q2, what do you think is driving that? Do you have foresight on contracts ending without securing new rigs or contracts yet? Or is there generally a longer period between contracts as rig churn increases?

Well, I'll be clear. We have visibility on one or two rigs coming down right now, so we know that, but we do expect that the industry account is going to be dropping and that we'll take a piece of that. We'll be bearing a piece of that. So I would say that there's a lot of moving pieces. I gave you the data on the rig bids we have out there right now. I remain pleasantly surprised by the volume of rig inquiries we have. So there might be some timing issues where a rig comes down in maybe late June, but gets reactivated in July or August. It's really kind of hard to see how it plays out, but the visibility right now is one or two not five or ten.

Yes. Got it. And just on the rig bids that you have outstanding now. Can you give us a bit of an indication of how those break down by customer type, by region, et cetera?

In the past, I have mentioned that the bidding activity serves as a gauge of interest. Typically, about one-third to one-quarter of those bids result in actual rig orders for us or other companies where we secure a portion. Looking ahead, we anticipate that a similar one-third or one-fourth will translate into real rigs over time, and we hope to capture our fair share of that.

Got it. Thanks for the color.

I will tell you, it's biased towards oil though, no question about that.

I'm not showing any further questions at this time. I'd like to turn the call back over to Lavonne for any closing or remarks.

That concludes our conference call for today. Thank you everyone for joining, and have a great day.

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.