Source: Helmerich & Payne
Helmerich & Payne (NYSE: HP), North America's largest land rig contractor by market share, believes that its value-added productivity enhancements should help garner higher dayrates for its rigs than peers earn. The Tulsa-based rig contractor believes that by offering superior execution and better performing rigs, it can meaningfully help customers reduce well costs over an extended period of time - and earn higher rates for themselves.
While this approach could hit revenue and pressure margins in the immediate future, it could potentially help Helmerich wrest a greater share of the US rig market in a protracted oil bear market, as well as in an eventual market recovery.
Bleak days immediately ahead
To be fair, Helmerich & Payne's management is expecting rig revenue days to decrease by up to 20% for the second fiscal quarter of 2016. Total revenue, as a result, should fall even further. This shouldn't be surprising given the market's general view that US shale oil supply needs to shrink in order to balance global crude oil supply and demand. The total onshore US rig count has already dropped a massive 73% over the last 17 months, with more active rigs expected to go offline in the first half of 2016. Needless to say, the next year is going to be rough for rig operators like HP.
...but management's focus is on the longer term
However, during last month's quarterly earnings call, Helmerich's management made it clear that the company isn't looking to further reduce dayrates for its best-in-class AC drive rigs, in spite of the storm clouds ahead. These AC drive rigs are used for drilling horizontal wells, and while that is precisely the type of rig that is being retired these days, this move means cash margins for active rigs shouldn't take a huge beating despite falling rig counts. This strategy is not without risks. Due to higher dayrates for its rigs, there's a risk that Helmerich may lose existing contracts as well as find it difficult to pocket new ones. Yet management feels that this move is the right one. Let's investigate.
Tailor-made for complex yet cost efficient wells
Oil producers are giving increasing importance to the quality of wells fracked as opposed to simply increasing the fracking, or lateral, length in shale wells. Oil exploration and production companies, looking for the biggest bang for their buck, are ensuring that they are drilling the sweetest spots, which involves geo-steering the drill-bit electronically. Helmerich's management argues that its computerized AC-drive rigs can control down-hole parameters more precisely.
In addition, Helmerich's FlexRigs are designed to facilitate multi-well pad drilling. Pad drilling helps eliminate rig-up and rig-down costs. From a single pad, multiple wells can be drilled, thus bringing down per well costs.
On an organizational level, Helmerich continues to improve efficiencies and performance on a daily basis. This, too, should contribute to lowering overall well costs. The following chart spells out Helmerich's value proposition in terms of efficiency. It also explains why a higher dayrate per rig helps to reduce overall well costs for the customer.
Source: Helmerich & Payne investor presentation
So far, so good
Over the past 18 months, as the oil industry has suffered its worst downturn in decades, Helmerich & Payne's market share in the US has actually gone up from 15.4% to 19.5% -- a testimony to its efficient services and superior rig performance. This is despite total US rig count dropping from 1,874 in July 2014 to 619 at the end of January 2016 -- in other words, Helmerich's rigs are falling idle at a much lower pace than those of peers.
Source: Baker Hughes rig count data & H&P investor presentation
So far the signs look positive. Helmerich & Payne's strategy to price its rigs higher than those of peers hasn't really affected its overall market share. Should oil prices move north and oil producers increase drilling activity, Helmerich & Payne's superior services could be in considerable demand.
Downside risks exist, though
While the above strategy appears sound, risks do exist. For example, customers may choose to stop drilling altogether until oil prices move north. That might not happen until 2017, or until global supply and demand balances are restored and crude oil inventories fall from their current sky-high levels. Already 226 rigs, or almost two-thirds of the company's US land rig fleet, are lying idle.
Also, Helmerich's economic moat looks narrow. A competent rival such as Nabors Industries Ltd. (NYSE: NBR) can easily offer similar services. The reason is that while Helmerich manufactures its own proprietary, high specification AC-drive rigs, crucial components such as the AC top-drives are sourced from third party hardware manufacturer National Oilwell Varco (NYSE: NOV). Technological superiority alone doesn't give Helmerich a huge advantage in the long run.
Foolish bottom line
Helmerich & Payne is definitely the best positioned US land driller today. While its peers can definitely catch up in the future, it looks highly unlikely. In a protracted oil bear market, the amount of investment required for competitors to catch up would be too much, and the rewards too little. That leaves Helmerich a lot of breathing space, and almost certainly warrants closer attention by Foolish investors.
