Weatherford: Spotlight On Upcoming Q3 Results & Geographic Mix

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Elevator Pitch

I rate Weatherford International’s (NASDAQ:WFRD) shares as a Hold.

In my prior August 9, 2022 update for Weatherford, I touched on WFRD’s Russian market exposure and reviewed the key metrics relating to the company’s Q2 2022 results.

I discuss about Weatherford’s upcoming third-quarter results announcement, WFRD’s capital allocation, and the company’s geographical mix in this latest article. I don’t have the confidence that WFRD will meet analysts’ expectations with its Q3 2022 financial results to be announced next week. On the flip side, I view Weatherford’s high proportion of revenue derived from international markets and its focus on paying down existing debt as key positives for the stock. Taking into account the pros and cons associated with WFRD, I assign a Hold rating to Weatherford.

Analysts’ Expectations Of WFRD’s Financial Performance

Weatherford will be reporting its Q3 2022 financial results next week on October 26, 2022 prior to trading hours. The market’s expectations with regards to WFRD’s financial performance in the near term are high.

Weatherford’s revenue has come in above the sell-side’s consensus estimates for 10 consecutive quarters between Q1 2020 and Q2 2022. When WFRD announced its second quarter results in late-July 2022, the company revised its full-year FY 2022 revenue growth guidance upwards from a “high single to low double digits” percentage previously to a “mid-teens” percentage.

The management guidance update prompted five of the six Wall Street analysts who have WFRD under their coverage to increase their respective 2022 top line forecasts for the company in the last three months. The current FY 2022 consensus revenue growth projection is +14.8% which is consistent with Weatherford’s guidance.

Weatherford also guided for its EBITDA margin to expand by a minimum of +1 percentage points in FY 2022. Analysts are even more bullish about WFRD’s expected improvement in profitability, as the consensus fiscal 2022 EBITDA margin (source: S&P Capital IQ) for Weatherford is 17.1%. In other words, Wall Street sees WFRD delivering an even better +1.4 percentage points expansion in EBITDA margin for fiscal 2022.

The Wall Street analysts are equally optimistic about WFRD’s third quarter results. The market consensus points to WFRD expanding its EBITDA margin by +0.5 percentage points from 17.5% in Q2 2022 to 18.0% in Q3 2022 as per S&P Capital IQ data. This is at the high end of Weatherford’s management guidance of a “25 to 50 basis points” EBITDA margin improvement on a QoQ basis as highlighted at its Q2 earnings call.

At the company’s second quarter results briefing, Weatherford highlighted that its Q3 2022 EBITDA margin guidance is dependent on the company “taking more advantage of some of that volume leverage”, and it also acknowledged that inflation is “certainly something that is impacting us.” In other words, if inflationary cost pressures have a larger-than-expected negative impact and WFRD’s actual volumes aren’t as good as hoped for, Weatherford’s actual third quarter EBITDA might disappoint investors.

In a nutshell, the Wall Street analysts have high expectations of Weatherford’s EBITDA margin improvement for Q3 2022 and FY 2022. There is a significant risk that WFRD’s actual EBITDA margin falls short of market expectations as a result of lower-than-expected volumes and headwinds relating to inflation.

Weatherford’s Capital Allocation

It is particularly relevant to watch WFRD’s capital allocation priorities, considering that Weatherford’s free cash flow is expected to grow significantly in the next few years.

The company’s management has guided for free cash flow of $100 million in fiscal 2022 as highlighted in its Q2 2022 earnings presentation. This is almost the same as the sell-side’s consensus FY 2022 free cash flow projection of $99 million as per S&P Capital IQ data. WFRD has not provided further guidance on free cash flow expectations in 2023 and beyond. But the Wall Street analysts see Weatherford’s free cash flow growing by +151% and +60% to $248 million and $397 million for FY 2023 and FY 2024, respectively according to data provided by S&P Capital IQ.

Weatherford’s recent announcement might provide clues as to how the company will allocate its excess capital and cash flow.

On October 18, 2022, WFRD issued a press release disclosing that “intends to use cash on hand to redeem $125 million principal amount of its 11.0% senior notes.” Weatherford highlighted specifically in the media release that “improving our capital structure efficiency” is the key reason behind this recent move. This is aligned with WFRD’s comments at the earlier Q2 2022 earnings briefing that “our first focus continues to be the repayment of debt.”

Based on S&P Capital IQ’s financial data, the sell-side forecasts that WFRD’s net leverage ratio will decrease from 1.90 times as of end-FY 2022 to 0.83 times as of end-FY 2024.

It is a relief to see that Weatherford has resisted the temptation to utilize its free cash flow for acquisitions or internal investments so as to pursue growth at any cost. Instead, WFRD has made the decision to place a strong emphasis on debt reduction, which I view as a prudent move from a capital allocation’s perspective.

WFRD’s Geographic Mix

One key thing that makes Weatherford stand out is the company’s geographic mix.

WFRD only earned a quarter of its revenue in the second quarter of 2022 from North America as revealed in its Q2 financial results presentation. Latin America, MENA/Asia Pacific and other international markets (comprising of Europe and Sub-Saharan Africa) contributed the remaining 25%, 33% and 17% of Weatherford’s Q2 2022 top line, respectively.

There are signs suggesting that Weatherford’s foreign markets exposure will be a tailwind for the company.

An October 6, 2022 Piper Sandler research report (not publicly available) titled “Assuming Coverage of Oil Service” noted that “international customer spend remains on track to increase mid-teens this year with the Middle East and Latin America growing the most.” In the Piper Sandler report, it was also highlighted that “2023 international spending” might potentially “be up 15% y/y.”

It is also noteworthy that WFRD recently secured a new contract win in the Middle East. Seeking Alpha News reported on September 12, 2022 that WFRD “received a five-year contract” that has a value in excess of $400 million “from state-owned Abu Dhabi National Oil Company (ADNOC) for directional drilling and logging-while-drilling services.”

As highlighted above, international markets accounted for three-quarters of Weatherford’s Q2 2022 top line, with Latin America and Middle East (part of the MENA/Asia Pacific geographic segment) being key revenue contributors for the company.

Closing Thoughts

Weatherford’s shares are rated as a Hold. I have a mixed view of WFRD’s shares. Analysts are too bullish on Weatherford’s near-term financial performance, so there is a risk that WFRD’s actual Q3 2022 profitability isn’t as good as what the sell-side is expecting. On the other hand, I am positive on Weatherford’s foreign markets exposure and its capital allocation priorities.

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