Hunting: An Oil Net-Net

When scrounging around for cigar butts, it is rare to find one that is covered by Wall Street. Hunting PLC, a supplier to the oil & gas industry, is one of these companies. Despite the research coverage, Hunting still trades below net working capital. Such is the revulsion to oil stocks today.

Hunting is headquartered in London, but has operations primarily in the US. It has a 100+ year history in industries such as shipping and transportation, and still has significant equity ownership by the Hunting family. Its primary focus today is making products for the upstream oil & gas industry. The majority of Hunting’s revenues are derived from US shale, though they also sell into offshore and subsea markets. Hunting’s exposure to shale has made it ground zero for the current oil downturn.

Hunting makes a variety of products such as premium pipes and perforating guns. They have a good reputation in the market, but essentially, they are levered to drilling & completing oil wells. Given the depletion curve in typical shale wells, shale requires a lot of drilling. And Hunting has benefited from this activity the past decade.

At this point, US rig counts and frac spreads are at very low levels. They are only slightly above the multi-decade lows hit earlier this year.

Will shale come back to a reasonable level? That’s the key question for Hunting. It depends on oil prices, as shale is the marginal producer. I have a constructive view on oil as discussed previously (Musings on Oil). I also believe that shale drilling has a future, in the US and abroad, though probably at lower levels than in the past.

The last cyclical low for the oil industry was 2015-2016. During that period, Hunting posted significant operating losses and took impairments on inventory and goodwill.

The 2020 cycle low is even lower. Hunting has already taken another round of impairments and write-offs. But they posted a trading update with “underlying” EBITDA results that were breakeven. This is a significant improvement from the 2016 level. They made the tough decisions on their business early and are not bleeding cash. Should EBITDA results stay breakeven, they should preserve their net current asset value and survive a long time.

Hunting holds a fair amount of inventory and should generate a significant amount of cash as the business contracts. In this way, the business is counter cyclical. Working capital will unwind as revenues decline.

Management seems capable and properly incentivized. They will continue to do tuck-in acquisitions. And most likely, they will stay focused on upstream oil and gas.

One potential risk for Hunting is actually the family ownership. They still own stock but aren’t really involved in the company other than being reliant on a dividend. In 2016, they raised a decent amount of equity to fund a dividend (at a price 3x higher than today). The quote from the annual letter was that the canceling of the dividend “caused grief to some of our loyal shareholders.” I’m assuming the descendants of Charles Hunting don’t see the same investment merit in the business as he did.

Given the strength of the balance sheet today, the funding of the dividend should not be an issue. But going forward, the family will more likely to be focused on receiving a dividend rather than more accretive uses for their cash. This may not be optimal for capital allocation.

I don’t know when shale drilling will recover. But if the environment reverts to some reasonable historical level (say 500 rigs in the US), Hunting should be solidly profitable and trade at a low multiple to its earnings.

For what it’s worth, Goldman Sachs thinks Hunting is worth about double the current price and rates it a “Buy.” Might be worth swimming with the vampire squid on this one.