Nine Energy Service: Haynesville Exposure Could Be An Issue (NYSE:NINE)

Nine Energy Service (NYSE:NINE) has been riding some nice industry tailwinds, but its Haynesville exposure and high leverage could become issues as 2023 progresses.

Company Profile

NINE is an energy service company that offers well completion services to oil and natural gas exploration and production companies primarily in North America. The company has operating facilities across the largest basins in the U.S. and Canada, including the Permian, Haynesville, Eagle Ford, MidCon, Barnett, Rockies, Marcellus, Utica, Bakken, and Western Canada.

The company generates revenue primarily through 4 service lines: cementing services, completion tools, coiled tubing, and wireline services.

For cementing services, the company creates cement slurries by blending cement and water with solid and liquid additives. These slurries require strong compressive strength as they are pumped between the casing and the wellbore of a well to help ensure casing integrity. The company creates proprietary blends to help get costs down and also to meet green standards, all the while being able to keep a well’s integrity.

The company also offers completion tools. Its main offering is composite and dissolvable frac plugs, but it also offers other completion tools such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers.

Coiled tubing services, meanwhile, are a method to stimulate and maintain wells. It is often used to help circulate a well and pump away any unwanted substances or debris. It is done using a long metal pipe that is spooled on a reel. Wireline services is similar to coiled tubing services, and is used for well completion, well intervention, and pipe recovery. Wireline Services, however, do not allow for the pumping of fluids in a well.

Opportunities and Risks

Not surprisingly, drilling activity is both one of the biggest opportunities and risks when it comes to an energy service company like NINE, as drilled wells usually become completed wells. And generally, drilling activity revolves around energy prices. Certain basins, like the Permian, will see solid drilling regardless, as long as the takeaway infrastructure is there, given its low breakeven.

However, solid energy prices can lead to strong activity in more swing basins. In 2022, NINE benefited from strong energy prices and drilling activity. However, it does face some risk with its exposure to the Haynesville, which saw a resurgence in 2022 given strong natural gas prices and its position near LNG export markets.

Earlier in the year, the company noted strong results in cementing services and coiled tubing from the Haynesville, where about 16% of its 2022 revenue came from. However, natural gas prices have collapsed below $3, which has tended to be bad for drilling activity in the basin in the past.

Natural gas E&P Antero (AR) called out the dynamics on the Haynesville on its Q4 call, noting that since 2011, every time natural gas prices have fallen below $3, rig counts in the Haynesville precipitously decline.

On its Q4 call, AR CFO Michael Kennedy said:

“On average, rigs declined 60% or 42 rigs through the last 3 cycles. But the Haynesville now, as the marginal supplier of natural gas and activity expected to fall significantly in the months ahead, is important to review the decline profile of the Haynesville.

“As displayed on the chart on the lower right-hand side of this page, the estimated annual base decline rates of the Haynesville are materially higher than that of Appalachia. With this being the first downward price cycle in which the Haynesville is the marginal supplier, this would suggest a more rapid supply response following an expected decline in rigs.”

Outside of rig activity, NINE is also subject to the supply/demand dynamics in the energy industry. On that front, the company has benefited from a combination of labor shortages and underinvestment by E&Ps, which has led to higher prices for oilfield service operators.

On its Q4 call, CEO Ann Fox said:

“While overall rig and frac activity increased year-over-year, I would categorize 2022 as more of a pricing story. Underinvestment in OFS equipment kept equipment undersupplied, and OFS companies did not have access to capital to invest in new or existing equipment. Additionally, the labor market remained extremely constrained. These 2 elements drove pricing leverage back towards service providers in 2022.

During 2022, we grew market share, growing our percentage of stages completed within wireline and completion tools from approximately 18% in 2021 to approximately 20% in 2022. Additionally, we grew our market share of rate follows and the basins we operate from approximately 17% in 2021 to approximately 19% in 2022. These market share gains came in conjunction with significant growth and profitability.”

On a more company-specific level, NINE is benefiting from the shift to dissolvable frac plugs, although its traditional composite plug business has also been doing well. However, its stinger dissolvable plug is margin accretive the company estimates it is the market leader is dissolvable plugs with a 20-25% market share in the U.S.

Valuation

NINE stock currently trades around 5.8x the 2023 consensus EBITDA of $104.6 million. Based on a 2024 consensus calling for EBITDA of $126 million, it trades at 4.8x.

It trades at a forward PE of 16x the FY24 consensus of 43 cents.

The company is projected to grow revenue 18% in 2023 to $672.4 million.

The company has about 3.5x leveraged at year-end and generated negative free cash flow.

NINE currently trades in the middle of pack in its peer group, but carries more leverage.

Conclusion

NINE has been riding some nice tailwinds in the oil service industry that has seen strong rig activity and better pricing. Meanwhile, it’s doing well in the dissolvable frac plug market.

That said, it has 30% exposure to natural gas basins, including 16% to the Haynesville, which has become the swing basin in the U.S. If history repeats itself, this basin is going to see a precipitous decline in rig count this year.

Given this exposure, as well as its debt load, and a lack of free cash flow generation even in a strong market environment, I think NINE looks like a bit of a value trap at the moment. The one analyst consensus is calling for a nice increase in 2023 EBITDA and revenue for the firm, but that might prove to be difficult in this market environment.