The febrile situation in the Middle East has forced analysts to reappraise their forecasts for oil prices and Bloomberg Economics has broken cover to predict that “if Israel ends up in direct conflict with Iran, prices could hit US$150 / barrel, over 70% above today’s levels.” This is because around 20-30% of global supply passes through the strait of Hormuz, the world’s most strategically important passage for international trade, which runs alongside the coast of Iran (as well as the UAE and Oman) and is just 21 miles wide at its narrowest point.
Once described by a former Iranian Prime minister as “our jugular vein,” the Strait has been claimed territorially several times by Iran, against international maritime law, and to borrow an infamous quote from the late US secretary of Defence, Donald Rumsfeld, it’s a “known unknown” that could unleash a global crisis. One company in the energy sector that is already on a tear is Hunting, which manufactures high-value precision tools and components used in oil & gas wells. The exciting thing here is that even without the benefit of an oil price spike, Hunting is trading particularly well and forecasts have been raised twice in a year. Zeus expects EBITDA to increase from US$52m in 2022 to US$96.8m this year and then US$124.8m in ’24 for eps of 25.7 cents (21.2p) and 38.2 cents (31.6p). A more bullish broker, Investec, expects US$99.5m and US$130.6m, and has also introduced a FY’25 forecast of US$163m for eps of 25.7 cents (21.2p), 39.8 cents (32.9p) and 53.9 cents (44.5p).
Underinvestment drives demand
The bullish forecasts reflect two factors. First, Hunting says the market environment is the best since oil was last at US$100 / barrel in 2014. Since that peak and the subsequent price collapses (initially due to a price war between Saudi Arabia and the US fracking upstarts, and lately because of the pandemic) the oil & gas majors have retrenched their upstream capital spend on exploration & production from US$1 trillion to less than US$400 billion. But Hunting says that with oil demand expected to increase from c. 102 million barrels per day (mmbopd) to c. 108 mmbopd by 2030, these cuts will lead to a 22 mmbopd “supply gap” opening up as key fields deplete. Consequently, capex on upstream spend in the industry has rebounded to around US$550 bn to at least the end of the decade.
Moving up value chain
The other reason for the buoyant forecasts is that Hunting is diversifying away from its legacy activity (perforating guns for fracking) where earnings visibility is at best four months, contracts are small and business is dependent on the number of active oil rigs, and has been busy expanding into less commoditised markets where margins are higher and contracts are bigger and of longer duration (up to 18 months). It was no coincidence that Hunting’s CEO remarkably stated that the outlook for earnings out to 2025 “is so bright you’ll need sunglasses”...
Order book surges over 50%
….And he’s backed it up with three super-league contract wins: US$86m for an offshore project in China for CNOOC announced in August ‘22; US$91m for Cairn Oil & Gas in Rajasthan, India in May; and a US$59m order in South America last month. That’s led to a surge in Hunting’s order book from US$326m as at June 2022 to US$560m. Excitingly, it’s also bidding for tenders worth another US$1 billion, roughly double a year ago according to CFO Bruce Ferguson, who I met with over the month. Ferguson says its success rate is around one in two and of that US$1 billion there’s two Middle East tenders, each for US$50m-US$100m, which could be announced before the year-end.
US$2 billion sales by 2030
Thanks to these wins at the very least Hunting should achieve forecasts, which drop the soon-to-be prospective PE to 9.0 and then just 6.7 and for a company about to be free of net debt, the shares are very cheap. But as they say, it’s Go Big or Go Home and in an impressive Capital Markets Day presentation, management introduced ambitious new targets.
From a base of US$726m sales and EBITDA margins of 7% last year, they are aiming for US$1,300 million and 15% margins by FY’25. The latter would imply EBITDA of US$195m, around 20% above Investec’s numbers. By 2030 they expect sales to hit a massive US$2,000m with a further rise in margins. Guidance is also for double digit dividend rises (FY’23 forecast 11 cents, yield 3.1%).
While the majority of sales growth will be organic, including deep water drilling, geothermal heat extraction and carbon capture utilisation and storage (CCUS) management have also telegraphed increased M&A activity, mostly debt financed (Hunting has a US$150m facility) to ensure shareholders receive bang for their buck.
History
Hunting can trace its roots back to 1874 when it was founded as a shipping business by veterinary surgeon Charles Hunting. Post World War II it became involved in air transportation, defence and the transportation and marketing of crude oil in Canada (Gibson). These have been sold and the proceeds have financed expansion into its sole remaining activity, Hunting Energy Services. The landmark acquisition to provide critical mass was Titan, a provider of perforating guns used in fracking, a controversial extraction technique in which millions of gallons of fluids are pumped through rock to release trapped gas.
At present, Hunting operates from 30 sites around the world including the US (multiple locations), Singapore, Indonesia, India, Mexico, Saudi Arabia and Holland while it can boast over 500 patents and trademarks across key technologies and geographies.
Forecasts by product
As I mentioned earlier, Hunting has since diversified into other areas and based on its own forecasts, its projected revenue for 2023 by product line is as follows:
- OCTG: 39%;
- Perforating Systems (Titan): 30%;
- Advanced Manufacturing: 10%;
- Subsea: 10%;
- Oher Manufacturing 11%.
OCTG
People often bemoan the lack of “lower hanging fruit” to describe the difficulty in finding those large oil & gas discoveries of yester-year and back in the late 1940s the average prospector drilled well shafts down to maybe 1,000 meters below the surface but with big finds harder to come by, operators nowadays must drill far deeper to around 3,000 metres. At that depth the environment is harsh and the drilling equipment must be able to withstand crushing pressure and torque without breaking down as profits can be quickly eaten up by such delays. This is where Hunting comes in.
Its largest product line by turnover is OCTG (39% forecast FY’23 sales), short for Oil Country Tubular Goods, which are durable steel pipes that go down the well shaft (bore holes). These include drill pipes (a heavy, seamless tube that rotates the drill bit and circulates drilling fluid); steel casing pipes (stabilising the well by lining the well shaft with cement to hold in place) and tubing pipes (which go inside the casing and help transport the oil up to the surface and processing facilities).
Around 80% OCTG sales are derived from its home US market with key customers including large US oil field contractors Schlumberger, Baker Hughes, Siemens and Halliburton. Importantly, Hunting is able to source its raw materials through strategic partnerships with four of the largest steel mill owners. Three are in China: Hyst (Hunan Province), Baosteel (Shanghai), Jiuli (Huzhou City) alongside Jindal Saw in India and are perfectly positioned to help Hunting expand outside the US with international now 20% OCTG sales.
Energy transition to add US$250m by 2030
Hunting believes OCTG will increase sales by 19% in the two years to 2025. Punchier still is that it expects it to contribute as much as 40% of the growth between FY25-FY30 to reach its US$2 billion goal. Its confidence is based on expansion in so-called energy transition markets such as geothermal heating, which is expected to almost double global capacity by 2030, and in carbon capture utilisation & storage (CCUS) and it’s targeting an additional US$250m revenues from energy transition by 2030. In Geothermal, which again involves drilling deep, Hunting’s pipes and connections are used because they can withstand very high temperatures with high resistance to corrosion, which is achieved through increased nickel content.
Perforating Systems
Next down in terms of size is Perforating Systems (30% forecast sales), which was Hunting’s leading business in the early 2010s when oil prices were high. Its emergence came thanks to the arrival of shale (or tight) oil & gas fracking as the dominant force in US energy production. After encasing a well to prevent any leaks, the fracking process consists of pumping mainly water but also chemical additives and sand down the shaft at very high pressure to fracture surrounding rock and create cracks and fissures through which the oil & gas then comes out. Titan supplies the perforating guns, which perforate (or shoot / blast holes in) the well shaft casing to allow hydrocarbons to flow into the well shaft from the surrounding rock outside. These perforating systems are used in the completion phase of the well, that is making the bottom of the hole ready for production. Its range also includes shaped (explosive) charges, detonating cords, firing systems, inspection and logging tools and various connections.
Trading wise, Hunting expects 10% growth this year in spite of reduced drilling rig activity in the US.
Sub Sea / Advanced Manufacturing
Excitingly, Hunting believes its two smaller product lines, Sub Sea and Advanced Manufacturing, will grow sales in the high 20s% by 2025. The former makes titanium stress joints, parts for floating production and storage offtake (FPSO) platforms and hydraulic couplings and valves for “Christmas Trees” control systems that sit on the ocean floor and manage pressure to ensure no blow-outs. This side is benefiting from soaring demand in places like Guyana, Brazil and West Africa, countries previously starved of investment.
Advanced Manufacturing is also going like a train, benefiting from Hunting’s determination to increase non oil & gas revenues from 7% to 25% of an enlarged base by 2030. It manufactures precision engineered parts such as turbines for Pratt & Whitney and GE and gear shafts and rotor blades for helicopters; periscopes for the US Navy; rocket parts for Space X; measurements while drilling in electronics and other products for the medical sector. As Ferguson says, it takes considerable time to be qualified as a supplier but the reward is sizeable contracts and high margin work.
Cost cuts boost margins
While the prospects for top line growth make Hunting an exciting proposition, an added benefit is that it has undergone a deep restructuring, involving a one third reduction in staff to 2,000, closure of several distribution centres in the US, a reduction in Singapore manufacturing facilities from three to one, and the exiting of a pipe trading business. All told, that’s reduced fixed costs by US$40m with a further US$6m expected by 2025 and Hunting says its revenue / EBITDA break-even has reduced from c. US$520m to just US$425m. The effect on profitability has already been explosive with EBITDA margins expected to recover from 7% in FY’22 to 10-11% this year and with 14-16% expected by FY’25 and further gains by 2030, one can see how Hunting could continue to beat forecasts.
445p price target
Investec has a 445p price target, some 50% above today’s level. The shares were extremely volatile earlier this year but have settled down with new highs in recent months. When investors wake up to the fact that its fortunes are no longer tied to oil rig counts, I believe the shares will re-rate. I am a buyer.
