China's economy has woken up from its long COVID slumber. The 12-month trend for one of the most reliable economic activity indicators, the Caixin Manufacturing PMI, has crossed into expansion levels for the first time since. The latest readings have surprised global markets and attracted a lot of attention from investors who are seeking to generate some alpha in the country.
This is especially true given the PMI readings, which have come in hot at 54.20 (any reading above 50 signifies economic expansion accruing to GDP).
With Goldman Sachs Group (NYSE: GS) and the oil trading powerhouse Vitol Group have stated their projections and base case for oil reaching $100 per barrel and above by the fourth quarter of 2023. With markets overestimating U.S. production and underestimating the coming demand from China and India, as well as the ongoing transitions towards renewable energy, the commodity's price may very well fulfill those predictions.
Higher oil prices incentivize all market participants to seek alternative energy sources, which is in line with the agendas of many leaders today.
Like a good driller HP is there
In a few simplified words, this is the value proposition that Helmerich & Payne (NYSE: HP) delivers to their customers and investors. Big oil companies like BP (NYSE:BP), Exxon Mobile (NYSE: XOM) and ConocoPhillips (NYSE: COP) look to HP as a leading provider of the equipment, personnel and machinery necessary to drill and explore for oil, and it is through these solutions and equipment contracts that the firm is in one of the best positions to benefit from the predictions made by top participants in the sector.
As contract revenues vary with a performance clause tied directly to the price of oil and the demand expended by the customer, HP's contracts will deliver higher deliverables as oil prices are set to increase and major suppliers scramble to meet this higher demand amid tight supply.
Judge a book by its content
Speaking of books, investors can find a very interesting story, perhaps one that others may miss, by dissecting HP's income and cash flow statements. While the income statement and subsequent EPS may prove unsatisfying for investors, a better story can be found in the cash flow statement.
The company generates earnings through leasing equipment and technology solutions so GAAP measures may distort its income statement greatly. However, looking at the cash flow statement, investors can find a hidden gem. With operating cash flows showcasing a 2017-2022 average margin of 21% and gross margins of 30.7%, HP is left with a cyclically adjusted ability to invest heavily in more efficient operations and, most importantly, create value for its shareholders.
According to HP's 2023 investor presentation, being able to invest heavily into R&D (at a 14% 6-year CAGR vs 2% revenue CAGR) has allowed the firm to become the preferred equipment and drilling solutions in the industry. Highlighting the achievement of revenue per rig level of $15 million USD in 2022 compared to $10 million USD in 2017 - that is a whopping 50% in 6 years - and allowing new technological and process breakthroughs to lower the overall CAPEX from over 30% to 18% in the same period.
Financial trifecta achieved
Lower capital intensity and higher revenue potential across their fixed asset base have allowed massive free cash flow yields for HP. These funds have allowed the company to achieve the most attractive capital structure within the peer group and be prosperous enough to return formidable cash to their shareholders as a result.
Carrying a 17% debt-to-total-capitalization structure on their balance sheet places HP above Patterson UTI Energy (NASDAQ: PTEN) with 33%, Nabors Industries (NYSE: NBR) with 83%, and Precision Drilling (NYSE: PDS) with 47%. Similar trends can be seen in their total liquidity of $1.2 billion USD, which is 200% of their total debt. No amount of crude oil volatility could throw HP off the strong leading position they have achieved.
HP' management has further decided to payout additional supplemental dividends for 2023. Following their guidance expecting cash flows from operations in the tune of $1.3 billion USD minus a CAPEX range for $425-$475 million USD, payouts in dividends plus share buybacks may come in around $310 million USD, or equivalent 5.5% to 7.5% total yield in cash returns alone. All the peers in the industry could not get even above 5% yield.
Ready to order?
Analysts are pointing to $60.91 as a consensus price target in HP, which may not reflect the updated predictions for oil rising back above $120 per barrel. The truth of the matter is some may wallow in inflation while others can enjoy a 5-7% yield and some additional upside by adding HP to their beloved watchlists.