No matter how lucrative an industry or how strong a business model may be, it can all be a moot point for investors if they don't trust that management is making the right moves for both the company and its shareholders.
Last month, Weatherford International (NYSE: WFT) lost some of the trust it had built up over the past year or so after it announced it would issue $1 billion in equity to raise capital on Sept. 21 and then canceled that share issuance the same day, when shares plummeted following the news.
Add the fact that the entire oil and gas industry has been on a more than 12-month decline and there has not been a lot to like about Weatherford's shares.
It can take a long time to rebuild investor trust, but there are a few things that management can do during this upcoming quarterly earnings report to get back on track. Here are three things that investors should look for that could show that Weatherford is going down the right path.
Make good on its operational cost-cutting measures
One thing that has hampered Weatherford in comparison to many peers recently has been its lower-than-average margins. For more than five years, the company's operational margins have trailed its competitors in the oil services space by a pretty consistent margin.
WFT EBITDA Margin (Quarterly) data by YCharts.
The decline has been very noticeable over the past couple of quarters because of the dip in oil service activity. Furthermore, the recent downturn has also overshadowed some of its efforts to boost margins. It has sold off several of its less profitable segments and has reduced its head count by close to 40% since 2013.
According to management, the most recent moves should result in cost savings of around $700 million annually, most of which would be coming from its most unprofitable segment in the North American market.
Saying that much in cost savings can be achieved is one thing, but actually achieving it is another. So, to reassure investors that these levels of cost savings are here to stay, management needs to show how these have helped the bottom line in the upcoming quarter and how it wil be able to maintain those cost improvements over time.
Bring impairment and restructuring costs to a grinding halt
A company can be forgiven from time to time when it has to write down an asset that has less value or needs to make some restructuring charges to the income statement. As much as we don't like to see them, they are a reality of business.
What is less acceptable, though, is when it continually has these kinds of "one-time" charges that happen quarter after quarter. Unfortunately for Weatherford, it is slipping fast into the latter category. Since the first quarter of 2014, it has had various charges related to restructuring, asset writedowns, and goodwill impairments totaling $1.3 billion. There can only be so many one-offs like these before investors start to lose faith.
Data source: Weatherford International investor presentation.
Management has said that these income hits will become insigificant by 2016, but based on the last couple of quarters, they don't appear to be slowing down anytime soon. Investors would take a lot more comfort in management's ability to work through the tough times if these "one-time" charges started to decrease significantly in the coming quarter.
Prove it can be free cash flow positive
The overarching goal of the company has been to return to a level of profitability, and two ways to get there are by reducing debt and becoming free cash flow positive. Thanks to some asset sales, it has been able to achieve some of that debt reduction. Total liabilities have declined 17% to $11.3 billion since the beginning of 2014. The second step in achieving that goal -- free cash flow positive -- has yet to be reached, though, and this quarter is a bit of a proving ground in that regard.
Management's goal for 2015 is to generate $150 million-$250 million in free cash flow after capital expenditures. Last quarter, Weatherford started to turn the corner with $100 million in free cash flow, but it is still running a $160 million cash deficit for the year. For Weatherford to meet its stated goal, it will need to produce some results this quarter. Otherwise, it may find itself coming up short of its target range.
The reason that lack of cash flow is so troublesome is that much of its plans for further debt reductions for the next three years depends on its ability to generate free cash flow.
Source: Weatherford International investor presentation.
If it can't generate $150 million-$250 million this year, how can investors be assured that it will be able to make the planned $950 million in free cash in 2016-2017 to pay down its debts?
What a Fool believes
Weatherford's management has the right idea when it comes to restoring the company to higher levels of profitability. A focus on reducing its debt through free cash flow generation will go a long way toward boosting returns over the long run.
That being said, it will take the company a while to execute this plan, and it's easier said than done. If Weatherford wants to regain some investor trust after that botched equity issuance decision, it has some work to do.
As an investor, checking in on the company's margins and seeing if it is on track to generate free cash flow while significantly reducing its "one-time" charges will be a good gauge as to whether it is doing the right things to rebuild investor trust.
