Normally a company's management won't flat out say that a quarter was disappointing. Typically, poor performance is described in veiled terms like "working through challenges" or "making progress." In that regard, you have to give Nabors Industries (NYSE:NBR) management some credit: It didn't meet expectations this past quarter, and it let investors know it wasn't happy with the result.
Then again, it's easy to say that when the issue is the inability to stay up to speed with huge demand growth in your industry. Let's take a glimpse over Nabors' results for the quarter and see why management thinks it can do better in the coming quarters.
By the numbers
|Results*||Q1 2017||Q4 2016||Q4 2016|
|Earnings per share||($0.52)||($1.18)||($1.41)|
One would think that cutting a quarterly loss in half would be a great step in the right direction, but these results fell well short of both Wall Street's and Nabors management's own expectations. Most of the gains the company realized this past quarter came from a lack of impairment charges, writedowns, and losses from its equity investment in the now bankrupt C&J Energy Services. Just to give an apples-to-apples comparison, Nabors earnings per share absent those charges in the first quarter of 2016 would have been $0.29 per share.
The reason that the company didn't meet expectations wasn't because of a lack of new work. Surprisingly, they were a result of too much work. Drilling activity in the U.S. has been rising fast lately, and rig companies have been scrambling to reactivate their fleets of idle equipment. In the case of Nabors, the costs to get that equipment back up and running ran extraordinarily high this quarter. In the U.S., where most of these rig reactivations have taken place, the average rig margin fell from $8,464 in the prior quarter to $4,484. Some of that was offset by a 23% increase in average rigs working in the U.S. for the quarter. Nabors experienced similar issues in Canada where active rigs increased from 13 to 22 from the prior quarter. The higher costs related to reactivating those rigs also came with a side of lower drilling activity in its international markets.
Because of the overall weakness for the quarter, cash flow generation was a little wanting. Nabors still has 8 rigs currently under construction and spent $183 million in the quarter on these rigs as well as other capitalized costs associated with upgrading existing rigs. The company's cash from operations couldn't keep pace with this spending rate and led to some significant cash burn. For a company that continues to struggle with a high debt load, this is less than ideal.
One thing that should help with its debt burden was Nabors' convertible note issuance in January. The $571 million in convertible notes only carry a 0.75% interest rate on them. Paying off some of its higher interest bearing notes due relatively soon should help ease its interest burden and hopefully get the company back to free cash flow positive; something the company has only accomplished in four of the past 10 years.
From the mouth of management
CEO Anthony Petrello, on the company missing expectations and what he expects in the coming quarters.
I am disappointed that our first quarter results were well short of our expectations as downtime and extraordinary costs more than offset the positive impact of a second consecutive quarter of increased revenue. This shortfall consisted primarily of lost revenues and higher costs related to the accelerated inspection and recertification of key structural components on a majority of the rigs in our largest international market and, to a lesser extent, higher than expected rig reactivation and relocation costs due to the rapid increase in demand for our U.S. lower 48 rigs.
On the positive side, we saw our U.S. lower 48 working rig count increase by 29% for the second quarter in a row. The 93 rigs working today represent a 166% increase since the low point last May. This outsized increase in utilization, combined with our improved market share, illustrates the superior performance of our best-in-class rigs and technology. International fundamentals continue to improve and our base business is solid as evidenced by the 4% increase in revenue we would have realized, absent the recertification downtime and the demobilization revenue in the fourth quarter.
What a Fool believes
For all the lame reasons that companies give for missing expectations, having to spend more to put assets to work is probably the one investors don't mind hearing that much. Management did mention that it expects reactivation costs to dwindle in the coming quarter, and many of its rigs on less than favorable contracts will be renegotiated at higher rates soon. Hopefully, we will see the fruits of this work in the coming quarter.
Ideally, Nabors will get several quarters of higher demand rates because the company could use it right now. While it has done a rather commendable job of turning over its fleet from an older, less capable group of rigs to one that can handle the challenges of today's shale drilling; it still has a lot of work to do to improve its balance sheet. Until we see some material improvement in lowering its debt load and consistently generating free cash flow, investors should probably stay away.