1. March 16, 2016
KEY ENERGY SERVICES INCORPORATED
KEG/NYSE
Continuing Coverage:
Efficient Operations ‘Key’ to Success in 2016
Investment Rating: Market Outperform
PRICE: $ 0.45 S&P 500: 2,027.22 DJIA: 17,325.76 RUSSELL 2000: 1,074.51
Dissolution of the international segment reduces revenues today, but stabilizes
cash flows in the long term
Cost‐cutting measures will improve operational efficiencies
Depressed oil prices still pose a major threat to Key
New refinancing activities and international asset sales improve Key’s liquidity
A new credit facility provides immediate liquidity and continued refinancing will
reduce default risk for Key
Our 12‐month target price is $0.70.
Valuation 2015 A 2016 E 2017 E
EPS $ (5.86) $ (0.73) $ (0.55)
P/E NM NM NM
CFPS $ (0.72) $ 0.44 $ 0.42
P/CFPS NM 1.0x 1.1x
Market Capitalization Stock Data
Equity Market Cap (MM): $ 72.45 52‐Week Range: 0.18 ‐ 2.79
Enterprise Value (MM): $ 832.95 12‐Month Stock Performance: ‐73.53%
Shares Outstanding (MM): 161.00 Dividend Yield: Nil
Estimated Float (MM): 133.30 Book Value Per Share: $ 0.87
6‐Mo. Avg. Daily Volume: 1,078,955 Beta: 2.70
Company Quick View:
Key knows the drill. Key Energy Services, Inc. is an oilfield service company
providing rig‐based well maintenance and workover services, coiled tubing
services, fluid management services, and fishing and rental services. As the
largest onshore, rig‐based well servicing contractor, Key currently operates in
the U.S., Mexico, Canada, and Russia.
Company Website: www.keyenergy.com
Analysts: Investment Research Manager:
Kathleen Carroll James Skipton
Pengpeng Tian
Yi‐Ting Liu
Zhitong Liu
The BURKENROAD REPORTS are produced solely as a part of an educational program of Tulane University's
Freeman School of Business. The reports are not investment advice and you should not and may not rely on
them in making any investment decision. You should consult an investment professional and/or conduct your
own primary research regarding any potential investment.
Wall Street's Farm Team
BURKENROADREPORTS
2. Key Energy Services Inc. (KEG) BURKENROAD REPORTS (www.burkenroad.org) March 16, 2016
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Figure 1: Five‐Year Stock Price Performance
Source: Yahoo! Finance
INVESTMENT SUMMARY
We give Key Energy Services, Inc. a Market Outperform rating and a 12‐month price target of
$0.70.
Key Energy Services, Inc. is an oil service company providing a full range of well services to
major oil companies, foreign national oil companies, and independent and natural gas
production companies. Key’s services include rig‐based well maintenance and workover
services, coiled tubing services, fluid management services, and fishing and rental services.
Key currently operates in the U.S., Mexico, Colombia, Ecuador, the Middle East, and Russia.
The Company also has a technology development and control system business based in
Canada.
Like other oilfield services company, Key Energy is facing a challenge of decreasing demand
for oil services from its customers, mainly exploration and production (E&P) companies. E&P
companies cut down on production due to falling oil prices, and therefore demand less well
and other related oilfield services. Key’s revenue has been decreasing since the third quarter
of 2014, and its net income has been negative since the first quarter of 2013. Key’s
management predicts a further, greater decline in oilfield service demand and, therefore, a
further decrease in revenue in the fourth quarter of 2015. The drop in revenue is unlikely to
last forever, however. Instead, revenues should recover when oil prices stabilize and the E&P
companies resume normal operations. However, the timing of an oil price recovery remains
uncertain.
In April 2015, Key Energy announced its intention to exit markets outside of America. This
decision will lean the Company’s production and cut down costs spent on unprofitable
segments. Key’s strategy is to sell or relocate assets like rigs from these business units. This
strategy induces revaluation of the assets’ fair market value and generates a large amount of
impairment loss. To further streamline the operation, the Company is also reducing staffing
and employee compensation.
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Key Energy’s capital expenditure (CAPEX) plan for 2016 is about $45 million, primarily related
to equipment replacement needs. The CAPEX is subjected to market conditions, including
activity levels, commodity prices, industry capacity, and specific customer needs. During the
first and second quarter of 2015, Key has generated a $305,550,000 debt for financing. The
newly raised debt increases the Company’s short‐term liquidity but raise its debt‐to equity
ratio from 1.2 to 4.1, significantly lowering the Company’s long‐term solvency. The majority of
this debt is due in 2020.
In summary, Key Energy is having a hard time during the low oil price period. The Company
has taken many strategies to streamline operations and cut down cost. Ultimately, the future
of the Company depends on a rise in and the recovery of oil prices.
Table 1: Historical Burkenroad Ratings and Prices
Report Date
Stock
Price
Rating
12‐Month
Target Price
03/09/15 $1.78 Market Outperform $2.50
03/28/14 $9.24 Market Underperform $9.00
03/18/13 $8.53 Market Perform $10.00
03/30/12 $15.45 Market Outperform $19.00
03/30/11 $15.41 Market Outperform $19.62
4/13/10 $10.53 Market Perform $11.41
INVESTMENT THESIS
Key Energy’s valuation depends mostly on improving oil prices. However, moving into 2016,
the Company can stabilize its operations and revenues with continued cost cutting practices,
such as dissolving its unsuccessful international segment and refinancing to improve its
liquidity.
Dissolution of the international segment reduces revenues today, but stabilizes cash flows
in the long term
In the third quarter of 2015, Key Energy began exiting foreign markets. The decreased
demand for Key’s services due to oil price volatility has led Key to only pursue markets that
are economically profitable. Due to exchange rate issues and unsuccessful operations/joint
ventures, Key exited all markets outside of North America. In 2015, the Company impaired
much of its equipment, sold it at a loss, or transported it back to the U.S. for storage. These
devaluations of assets and operating losses will greatly hurt Key’s revenue in 2015. However,
the Company believes that the exit from foreign markets will improve future cash flows as the
Company refocuses its efforts on North America.
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Cost‐cutting measures will improve operational efficiencies
Key adjusted its strategy to focus on cutting costs and building new revenue streams in order
to survive the recent oil crisis and unfavorable market. Exiting international markets was a
part of this strategy, however, the plan is more comprehensive than focusing on North
American operations. Key continues to limit capital expenditures to $40 million or less in
2016, compared to CAPEX spending of roughly $60 million in 2015. Key also continues to cut
costs through widespread layoffs, cutting its workforce in half in the first three quarters of
2015. In the third quarter of 2015, Key undertook another round of layoffs by consolidating its
maintenance group into a single team responsible for servicing rigs, trucks, and coiled tubing
units and by reducing its functional support segment by geographically grouping personnel. In
addition to reducing headcount, Key also reduced wages and closed some of its facilities.
Depressed oil prices still pose a major threat to Key
There is definitely an air of pessimism spreading across the oil market opinion. Speculators are
sometimes stimulated by bullish news, which could push oil prices to ramp up, but it has a
long way to go before the fundamentals of commodity prices become assuredly sound. Key
Energy, like all energy‐related companies, is looking forward to higher oil prices, or at least a
positive outlook on oil prices, because its existing and potential customers will increase capital
expenditure and resume production. Otherwise, while low prices are sustained, the Company
will continue to focus on its core business and reduce expenses to withstand the cyclical
downturn. According to the Energy Information Administration’s projection as seen in Figure
2, the West Texas Intermediate (WTI) oil price should slowly come back to $50 per barrel by
the middle of 2017, which is a healthy price for Key.
Figure 2: West Texas Intermediate (WTI) Crude Oil Price Forecast (U.S. dollars per barrel)
Source: EIA, U.S. Crude Oil Prices: West Texas Intermediate 2014‐2017 March 2016
5. Key Energy Services Inc. (KEG) BURKENROAD REPORTS (www.burkenroad.org) March 16, 2016
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New refinancing activities and international asset sales improve Key’s liquidity
In the second quarter of 2015, the Company replaced the $400 million revolving credit facility
that was set to expire in March of 2016, with a $100 million asset based lending (ABL) credit
facility and a $315 million term loan. As a result, it accumulated interest payment pressure
because of the rise in financing costs in the current market environment. Cash inflow from
refinancing activities and international asset sales replenished working capital and improved
the Company’s tight liquidity condition. The consensus is that Key Energy still needs to cope
with its tight liquidity concerns if the prices go against its customers for the following year.
Currently, the Company is reducing Foreign Corrupt Practices Act and general and
administrative (G&A) expenses and downsizing its workforce to maintain cash in balance. Due
to the nature of the business, it is necessary for the Company to cut its labor costs because
wages account for such a large portion of its variable production costs, which must be
reduced to offset high fixed costs and to react the difficult market. Going forward, Key Energy
will continue to remain within its covenants to avoid penalties in case further refinancing
activities are needed if the market environment fails to improve.
A new credit facility provides immediate liquidity and continued refinancing will reduce
default risk for Key
Key Energy improved its liquidity over the past year. In June 2015 the Company refinanced its
debt to be due in 2020 and paid off its debt issued in 2011. This refinancing improved Key’s
liquidity by decreasing the Company’s short‐term debt and restructuring the long‐term debt
to provide funds for Key’s use in this unfavorable market over the next few years. In 2015, the
Company also generated a large amount of cash by selling off its foreign business units and by
significantly cutting expenses primarily through headcount reductions to offset some of the
Company’s decreased revenues. However, Key Energy still faces liquidity and cash issues,
especially in the upcoming year. With a large amount of long‐term debt, expenses already cut
significantly, poor revenue, a dwindling cash reserve, and illiquid and idle assets, the Company
must generate a positive operating cash flow in 2016 to secure its business.
Although the June 2015 refinancing increased current liquidity for the Company, the new
credit line requires Key to maintain a certain level of liquidity and remain in a somewhat
stable/profitable financial position. Due to a specified asset coverage ratio and a certain fixed
charge coverage ratio covenant, Key will need to be careful in order to support this
refinancing into the future. Additionally, the new credit line includes variable rate interest
payments, putting Key at significant risk for interest rate changes and increased indebtedness.
If Key fails to pay its debtors because of an increased interest rate or because of a weak
financial position due to the poor market, the Company will need to pay‐off its debt on an
accelerated schedule, potentially causing the Company to default.
Over the past few years Key has operated with a high level of debt, which shows that Key and
its competitors are susceptible to market volatility yet can still survive in an unfavorable
climate. Key has taken extreme cost cutting measures, especially in its workforce, to keep
earnings as positive as possible; however, the Company does not have the ability to continue
this strategy and must start generating a profit.
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Key will not be able to support its operations, its necessary capital expenditures to compete in
the industry, or its financial obligations without revenue and positive cash flow. In 2015, the
financial state of the Company appears worse than a normal cyclical downturn caused by a
harsh oil market. Many measures of Key’s financial performance are significantly lower than
historical averages, such as a return on investment (ROI) of (153.16)% in 2015 and a debt‐to‐
equity ratio of 6.88 in 2015, which raises concerns about the Company’s risk of default. An
Altman Z‐score is another measure of a company’s risk of default; Key’s current Z‐score of
(2.54) means that the Company has a high risk of default. In 2013 and 2014, Key was also at a
high risk of default with Z‐scores of 1.77 and 0.61; however, the Z‐score drop to (2.54) in 2015
is highly concerning. This significant drop is likely due to the huge loss of earnings before
interest and taxes (EBIT) and the small amount of working capital from the decline in oil
prices.
The combination of financial success measures and the negative earnings of the Company
show the poor state of Key and its operations going into 2016. Key will need to reconsider its
strategy as well as its financing structure in the long term in order to be profitable in the
future. Thus, liquidity risk and default risk for Key is an imminent threat to the Company and
its operations.
VALUATION
We arrived at a valuation of $0.70 using a price to cash flow ratio multiple derived from the
averages of peer companies. The peer group we used includes: Nabors Industry, Pioneer
Energy Services, and Basic Energy Services. When analyzing peer performance, we also
included Helmerich & Payne, Inc. for comparison. However, when deriving a valuation for the
12‐month target price, we excluded Helmerich & Payne from our calculation because its
performance in the past 12 months was so much better than other companies in the peer
group that we considered it an outlier. Most of the oilfield services companies had negative
earnings because of low oil prices. Therefore, we are unable to use earning‐based valuation
multiples like price to earnings (P/E), enterprise value to earnings before interest and taxes
(EV/EBIT), or enterprise value to earnings before interest, taxes, depreciation, and
amortization (EV/EBITDA) ratios. We did not include EV to sales ratio because the current low
sales rendered the multiple too high and unreasonable. Also, we did not include price to book
value (P/BV) ratio because it did not produce sufficiently reasonable result.
Peer Group Price to Cash Flow per Share Multiple
The price to cash flow per share multiple is derived from averaging the price to cash flow of
the peer group. The multiple is 1.71. We then multiply the projected operating cash flow per
share ratio for the next four quarters by 1.71, which gave us the target price of $0.70 per
share.
7. Key Energy Services Inc. (KEG) BURKENROAD REPORTS (www.burkenroad.org) March 16, 2016
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INDUSTRY ANALYSIS
Key Energy is a competitor in the large U.S. onshore oilfield services industry. IBISWorld
estimates the industry revenue will grow at an annualized rate of 3.5% to $122.8 billion over
the next five years, although 2016 growth is predicted to be only 0.8% because of low crude
oil prices. Throughout the first three quarters of 2015, oilfield services companies like Key
Energy were negatively affected by low oil prices. The situation is expected to remain the
same throughout 2016 as exploration and production (E&P) companies cut expenditures and
reduce activities. Oil prices are the dominant factor for E&P capital spending, and E&P capital
spending is the driving factor for oilfield services revenues.
Oil prices have continued to plummet in the past year, from a high of $52.98 per barrel (Bbl)
on August 31, 2015 to a low of $28.35/Bbl on January 20, 2016, as a result of global
oversupply. The over‐supply situation is expected to continue in 2016, because deepwater
and ultra‐deep water crude oil production projects in the Gulf of Mexico (GOM) are now
coming online. The new projects coming online in 2016 and beyond are likely to bring GOM
production to record highs, which further depress the oil prices worldwide. As a result, U.S.‐
based oilfield services companies are expected to continue struggling throughout 2016.
E&P companies should cut oil production to balance oil prices when the market faces an over‐
supply situation. However, Saudi Arabia, the de facto leader of the Organization of Petroleum
Exporting Countries (OPEC), is the world’s lowest cost producer. Any reduced oil production
will be fulfilled by Saudi Arabia, which is using this opportunity to capture more market share.
To retain the market share in the energy market, U.S. shale producers have no other options
but to maintain current production levels.
The average period for oil prices to return to the historical standard is 17 months. The slowing
growth rate in China, the stronger U.S. dollar, and the collapsing euro all contribute to the
future price. So, returning to normal oil prices could take much longer than the average
period. During this “game” period, Saudi Arabia will continue to pump at the current or even
higher rate, trying to squeeze out the non‐OPEC competitors.
Halliburton, the second largest global oil services group, was forced to delay for a second time
its planned $26 billion acquisition of rival Baker Hughes, after failing to reach an agreement
with U.S. regulators. Instead, the two companies agreed on a final deadline of April 30, 2016
to close the deal. Once the acquisition succeeds in 2016, the potential economies of scale will
further lower the cost of operations for Halliburton. Consequently, the smaller oilfield services
companies will suffer more.
Bargaining Power of Suppliers
The bargaining power of suppliers is moderate. Inputs for the oilfield services industry
includes oilfield equipment like rigs and pipelines, and raw materials like cement and chemical
compounds. The suppliers for the oil service industry like Key Energy are oilfield equipment
manufacturers and raw material vendors. The raw material has no significant difference
among suppliers.
8. Key Energy Services Inc. (KEG) BURKENROAD REPORTS (www.burkenroad.org) March 16, 2016
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Therefore, oilfield service companies gain bargaining power because of the similarity of
supplier inputs. However, the oilfield equipment manufacturing industry is highly
concentrated. Therefore, equipment suppliers have bargaining power over oilfield services
companies because of the reduced competition in that industry.
Bargaining Power of Buyers
The bargaining power of buyers is strong. The oilfield service industry is competitive, so
buyers benefit from lower prices as a result of the competition. At the same time, the buyers
of oilfield service companies are oil companies that drill and produce oil. The services the
oilfield industry provides have no significant difference among companies. Therefore, the
industry is very price elastic. In addition, giant companies in the oil industry like Schlumberger,
Halliburton, and Baker Hughes have even stronger bargaining power over small oilfield service
companies.
Threat of New Entrants
The threat of new entrants into the oil and gas field services industry is medium to high due to
increasing barriers to entry and high capital requirements. This industry requires significant
capital investment to enter because drilling equipment is expensive, implementing drilling
activities requires a high level of skill, and maintaining constant operations employs a large
workforce. Additionally, players in the oil and gas field services industry compete based on the
quality of technology. Constantly obtaining new and high quality technology through research
and development also requires a significant capital investment. In addition to capital
investment, small companies also face barriers to entry from larger companies with more
resources because these large companies have more potential to vary operations, and to
better retain customers by meeting changes in demand. Lastly, all oil and gas service
providers face the barrier of the national and global regulatory environment, which is
increasing rapidly. Environmental laws, capital requirements to back drilling activities, and
other related regulations that affect oil and gas companies prevent many players from
entering the industry.
Availability of Substitutes
The availability of substitutes for the oil and gas field services industry is relatively low. Key
Energy provides very expensive equipment and highly developed technology to its customers
where no direct substitutes exist. While some customers can become more integrated and act
as both service providers as well as E&P companies, this threat of substitution is highly
unlikely because most of Key’s customers do not have the capital or resources to internalize
these support services. For this reason, unfavorable market conditions and increased
competition are the major threats to Key, not substitutes. Additionally, the increase in
alternative drilling practices, such as fracking and horizontal drilling, expanded the type of
equipment and services Key provides without increasing the presence of substitutes. Thus, the
availability of substitutes is very low and non‐threatening for the industry.
9. Key Energy Services Inc. (KEG) BURKENROAD REPORTS (www.burkenroad.org) March 16, 2016
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Competitive Rivals
Key Energy targets a segment of the oil and gas well drilling and field services market that is
more competitive than other segments in the oil and gas industry. The Company faces direct
competition in each business line. Some direct competitors in Key’s coiled tubing service
business includes industrial giants, such as Schlumberger Ltd., Baker Hughes Incorporated,
and Halliburton Company. Constantly updated technologies and economies of scale provide a
big competitive advantage to the companies with large market capitalizations. In addition,
numerous smaller companies compete with the Company in each business line. Those small
enterprises have more specialized technological solutions and focus on specific regions.
ABOUT KEY ENERGY
Key Energy Services, Inc. (KEG/NYSE) is one of the largest onshore, rig‐based well servicing
contractors that operate in the U.S. The Company provides services such as contract drilling,
well completion, workover, fluid management, coiled tubing, and fishing and rental services
to major and independent exploration and production (E&P) companies within oil and gas
industry. The Company also operates in Mexico, Colombia, Ecuador, the Middle East, and
Russia, and has stakes in a Canada‐based and Russia‐based oil field companies.
History
Yale E Key founded Key Energy, initially under the name National Environmental Group, Inc.,
incorporated the Company in 1977, and commenced operations in 1978. It is headquartered
in Houston, Texas. The Company launched its initial public offering (IPO) on the New York
Stock Exchange (NYSE) in October 1980, and in 1992, the Company changed its name to Key
Energy Group, Inc. to highlight its business model, which focuses on energy services. In 1998,
it changed its name to Key Energy Services, Inc.
In 2008, Key Energy acquired a 26% interest in OOO Geostream Service Group for $17.4
million. Geostream is a limited liability company that provides a wide range of drilling,
workover, and reservoir engineering service based in Russia. In 2009, Key acquired an
additional 24% interest for $16.4 million, gaining a controlling interest with representation on
Geostream’s board of directors.
In 2010, Key energy formed a joint venture, AlMansoori‐Key Energy Service, LLC, with
AlMansoori Petroleum Services, LLC to engage in conventional workover and drilling, coiling
tubing, fluid management, and pipe handling services. Key energy owns a 49% interest in the
LLC, controlling three of five board of directors’ seats, and holding a controlling financial
interest. In 2013, Key dissolved AlMansoori‐Key Energy Services, LLC and acquired the
underlying business for $5.1 million.
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Products and Services
In the third quarter of 2015, U.S. Rig Services accounted for 48% of the Company’s revenue,
Fluid Management made up 20% of revenue, Coiled Tubing accounted for 12%, and Fishing
and Rental Services generated 16% of Key’s revenue. The International segment only
contributed 4% of the Company’s revenue in the third quarter of 2015. Revenues in all
segments decreased in the third quarter of 2015 due to continually low oil prices and
increased impairment expenses due to Company restructuring and strategic changes.
Rig Services: Key Energy’s Rig Services segment is the Company’s largest revenue‐generating
segment. The segment’s services include standard well drilling, recompletion, maintenance,
and abandonment processes as well as specialty services, such as horizontal drilling for Key’s
largest customers. Key services many types of wells and outfits many of its rigs with KeyView
technology to gather operational data and provide a safety control system. As the oil and gas
industry continues deteriorating, Key Energy is focusing on providing more maintenance
services and enhancing production activities for its customers.
Fluid Management: This segment provides customers with transportation and well‐side
storage services as well as disposal services for the various fluids used in drilling, maintenance,
and other related activities. This segment suffered in 2015 due to decreased customer
spending and drilling activity.
Coiled Tubing Services: This segment acts as support for maintenance activities, specialty
drilling activities, and various other applications to Key’s provided services. The Coiled Tubing
Services segment has also suffered from unfavorable market conditions.
Fishing and Rental Services: Through this segment, Key provides a full line of equipment
designed for use in onshore and offshore drilling and workover services, including the
Company’s Enhanced Oilfield Technology business unit. During the third quarter of 2015 Key
held certain assets from the Enhanced Oilfield Technology business unit for sale and expects
to complete the sale before year‐end. Key recorded an impairment loss of $6 million. During
the third quarter, Key recorded a large impairment of goodwill and fixed assets for the
segment.
International Operations: Until April 2015, Key Energy operated global subsidiaries in Mexico,
Colombia, Ecuador, Russia, Bahrain, Oman, and Canada. However, unfavorable market
conditions spurred the Company’s decision to exit foreign markets outside of North America
by selling assets or relocating rigs to the U.S., starting in the second quarter of 2015. In the
second quarter of 2015, Key Energy reported certain assets from the Oman business unit as
assets held for sale and expects to sell these assets by the end of the year, recording an
impairment of fixed assets of $21.4 million. In the third quarter of 2015, the Company
transferred four rigs from Ecuador to the U.S. and sold the remaining assets, recording an
impairment of $4.1 million. Additionally, Key transferred one rig to the U.S. from Colombia in
the third quarter of 2015 and plans to sell or relocate the remaining 13 rigs, as well as
remaining property, equipment, and inventories, in the fourth quarter. Further, the Company
recorded an impairment of $25.3 million for its Colombian business unit. Key is also
negotiating a sale of the Bahrain business unit for $4.9 million and expects the sale to close by
the end of 2015. Finally, Key recorded $7 million impairment for its Bahraini business unit.
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Strategy
Since 2014, continually dropping oil prices have eroded Key Energy’s revenue and significantly
challenged the Company’s operations. To respond to the challenge, Key Energy reduced its
cost structure and streamlined its operations. In the third quarter of 2015, direct operating
expenses decreased by 32% compared to the third quarter of 2014. General and
administrative expenses have also decreased. The primary reasons for the decreases include
cuts in staffing, wages, and maintenance expenses as the Company seeks to reduce its cost
structure. In April 2015, Key Energy announced its intention to exit markets outside of North
America and to sell or relocate the assets of the businesses operating in these markets.
In addition to dealing with the current challenge, Key Energy’s long‐term core strategy is to
enhance business segments that focus on extending the life and recovery of a well throughout
the well’s life. The demand for these kinds of well services is recurring and, therefore, less
volatile than drilling and completion services. Figure 3 shows the typical life cycle of an oil
well.
Figure 3: Life‐Cycle of an Oil Well
Source: Key Energy, Presentation on Capital One Security Energy Conference Dec 9, 2015
Key Energy also emphasizes services for horizontal wells. Despite the oil price drop, the
number of horizontal oil wells in production has been increasing since 2011 and the Company
predicts continual increases in the coming years. As horizontal oil wells increase, the demand
for well services will increase in the future, especially when these wells age and need rework
or maintenance, therefore bringing Key Energy a larger activity base for revenue in the future.
Figure 4 shows the historical and predicted number of horizontal wells in production and the
number of horizontal wells that are, or will be, more than four years old. The older wells
require more services like maintenance and reworking.
12. Key Energy Services Inc. (KEG) BURKENROAD REPORTS (www.burkenroad.org) March 16, 2016
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Figure 4: Historical and predicted number of horizontal wells in production
Source: Key Energy Presentation on Capital One Security Energy Conference Dec 9, 2015
Company Competition
Key Energy has several direct and indirect competitors throughout its multiple business
segments. The Company’s main competitors are Nabors Industries Ltd. (NBR), Forbes Energy
Services (FES), Basic Energy Services, Inc. (BAS), Pioneer Energy Services Corp. (PES), and
Superior Energy Services, Inc. (SPN). Key Energy’s competitors mainly operate regionally in the
Permian Basin in West Texas and the Bakken Shale in Montana, North Dakota, and Canada.
Key Energy’s market capitalization is the smallest among its main competitors, but the
Company remains competitive through its high‐capacity rigs and relatively lower services
price.
Recent Development
Since the beginning of 2015, oil prices have dropped nearly 70 percent and are expected to
stay low throughout 2016. The low oil prices have resulted in reduced customer activity and a
reduction in revenue. Key Energy was recently notified that it is not in compliance with the
NYSE’s listing standard because the closing price of Key Energy’s common stock was less than
$1 over a consecutive 30‐day trading period. The Company plans to implement a reverse 1‐
for‐10 stock split to avoid de‐listing as long as it gets stockholders’ approval in 2016.
In the third quarter of 2015, Key Energy shut down its international businesses in Colombia,
Ecuador and Oman, cutting almost all of the employees in these areas and selling off
equipment. The Company has found a buyer for its business in Bahrain and it remains in
discussion with potential buyers that are interested in its Russian segment. Key Energy has
exited its operations in the Middle East and South America. Although the business in its
Mexico segment decreased by over one‐third from the second quarter in 2015, Key Energy
still plans to operate its Mexico segment.
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PEER ANALYSIS
Key Energy’s direct competitors are found in the oilfield services industry. The competitors
are Nabors Industries Ltd., Pioneer Energy Services Corp., Basic Energy Services, Inc., and
Helmerich & Payne, Inc. Table 2 presents the key financial ratios and indicators for Key Energy
and its competitors.
Table 2: Peer Analysis
Company Ticker
Mkt Cap
(USD)
P/E
EPS
(ttm)
P/S
Dividend
Yield
Debt/
Equity
(LFY)
ROE
(LFY)
Industry IND 287.97M 17.81 N/A 0.79 5.8% 22.8 0.0%
Key Energy
Services
KEG 42.54M N/A (5.26) 0.05 N/A
329.6
1
(115.61)
Nabors
Industries
NBR 2.19B N/A (3.79) 0.5 N/A 83.05 (20.32%)
Pioneer Energy
Services
PES 86.43M N/A (2.41) 0.12 N/A
105.4
3
(33.22%)
Basic Energy
Services
BAS 95.88M N/A (5.05) 0.09 N/A
556.9
6
(78.42%)
Helmerich &
Payne, Inc
HP 5.40B 23.15 2.16 2.11 2.75 10.20 4.81%
Source: Yahoo! Finance February 1, 2016
Nabors Industries Ltd. (NBR/NYSE)
Nabors Industries Ltd. Is on oilfield services company that competes directly with Key Energy
in U.S. rig‐based services and fluid management services. Nabors owns and operates the
world’s largest land‐based drilling rig fleet and is a leading provider of offshore platform
workover and drilling rigs in the U.S. and multiple international markets. Nabors provides
drilling technology and equipment, directional drilling and oilfield services in most of the
significant oil and gas markets in the world. In October 2015, NBR drew the available $325
million off of its unsecured term loan facility. This will increase the company’s debt burden
further.
Pioneer Energy Services Corp. (PES/NYSE)
Pioneer Energy Services provides contract drilling services and production services for major
E&P companies in the U.S. and Columbia. Key Energy and Pioneer Energy compete directly on
the drilling services, and occupy similar market share. Like Key, Pioneer owns a large number
of workover rigs as a percentage of its total fleet. In December 2015, Pioneer Energy Services
sold four rigs and renegotiated its revolving credit with ten banks after the oil prices hit lows.
Pioneer Energy Services has spent the last year trimming its budget. It had 62 drilling rigs at
the beginning of 2015 but reported selling 32 throughout the year. Pioneer Energy deployed
four new rigs in 2015 bringing the company's fleet to 34. Combined with the company’s
revolving credit situation, it is evident Pioneer Energy is facing free cash flow issues.
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Basic Energy Services Inc. (BAS/NYSE)
Basic Energy Services, Inc. is in the Well Site Services industry and provides well servicing, fluid
services, pumping services, and rental/fishing tools. Key Energy and Basic Energy both focus
on the onshore oil and natural gas drilling industry. The operating data for December 2015
shows that the well serving rigs utilization rate decreased from 60 percent in 2014 to only 36
percent in 2015. The drilling rigs utilization rate plummeted from 87 percent in 2014 to 2
percent in 2015.
Helmerich & Payne, Inc. (HP/NYSE)
Helmerich & Payne (H&P) engages in the contract drilling of oil and gas wells and specializes in
onshore and offshore drilling. The company operates through three segments: U.S. Land,
Offshore, and International Land. H&P holds leading positions in many of the major shale
plays and oil & gas basins, such as the Permian Basin, Eagle Ford Shale, Bakken Shale, and
Niobrara Shale. Key Energy directly competes with H&P in Permian Basin and Bakken Shale.
H&P’s revenues over the last two years have averaged close to $2.6 billion, compared to Key
Energy’s $1 billion in revenues. H&P’s $5.40 billion market capitalization is much larger than
Key Energy’s $42.54 million market cap.
MANAGEMENT PERFORMANCE AND BACKGROUND
Key Energy’s management team includes professionals with various backgrounds in the oil
industry. The management team includes Richard J. Alario as Chief Executive Officer and
Director, appointed in 2015, Robert Wayne Drummond as President, Chief Operation Officer,
and Director, appointed in 2015, John Marshall Dodson as Chief Financial Officer, and
Director, appointed in 2013, Kim B. Clark as Chief People Officer, Senior Vice President—
Administration, appointed in 2009, Jeffrey S. Skelly, Senior Vice President— Rig Services, and
Operations Support, appointed in 2013, Mark Alan Cox as Chief Accounting Officer, Vice
President, and Controller, appointed in 2012, and West P. Gotcher as Head‐Investor
Relations, appointed in 2013.
We used return on invested capital (ROIC) to measure management’s performance. ROIC is
calculated as ((Net Income‐ Dividend)/ Capital.) ROIC assesses how efficient a company is at
generating profit on the funds it invests in the business. Table 3 shows Key Energy’s ROIC
compared with its peers. Though all of Key Energy’s peers report a decreased ROIC due to the
recent oil price drop, Key Energy’s decline in ROIC is more severe than its peer. Specifically,
Key has a (48.79%) ROIC in the past 12 months, which is the lowest among its peers.
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Table 3: ROIC of Key Energy and Peers
Year 2011 2012 2013 2014 TTM
Key Energy Services 7.69% 2.07% 1.28% (7.39%) (48.79%)
Peer Average 7.32% 7.38% 4.99% 3.72% (7.83%)
Nabors Industries Ltd 4.26% 3.76% 2.82% (5.34%) (10.13%)
Pioneer Energy Services Corp 3.79% 5.41% (0.46%) (0.82%) (15.05%)
Basic Energy Services 8.35% 5.15% 0.60% 4.32% (13.87%)
Helmerich & Payne, Inc. 12.86% 15.23% 16.98% 14.79% 8.23%
Source: Morningstar February 3, 2016
Management Background
Richard J. Alario
Chief Executive Officer and Chairman of the Board (60)
Richard “Dick” Alario joined Key Energy as Chief Executive Officer in August, 2004 from BJ
Service where he was Vice President. He has held a number of leadership positions managing
oilfield service businesses in international markets, including the U.S., United Kingdom,
Europe, Latin America, and the Middle East. He is also Chairman Ex‐Officio of National Ocean
Industries Association (NOIA), and a Director of Kirby Corporation (NYSE: KEX) and Chairman
of its Corporate Governance and Nominating Committee. He also serves as a Director of
DistributionNOW (DNOW), Chairman of its Compensation Committee, and as a member of its
Corporate Governance and Nominating Committees. In previous years, he worked for the
Board of Directors of the Louisiana Gulf Coast Oil Exposition, the Louisiana Association of
Business and Industry, and the Louisiana State University Department of Petroleum
Engineering Advisory Council. In 2008, he was named Ernst & Young’s “Entrepreneur of the
Year” in the Energy category for the Gulf Coast Region. He graduated from Louisiana State
University with a Bachelor of Arts.
Robert Drummond
President and Chief Operating Officer (55)
Robert Drummond joined the Company as President and Chief Operating Officer on June 22,
2015. In 2016, Mr. Drummond will also take over as Chief Executive Officer (CEO). Prior to
joining Key, Mr. Drummond worked in Schlumberger for 31 years, most recently serving as
President of Schlumberger Limited's North American business unit. He received B.S. degree in
Mineral Engineering/Petroleum from the University of Alabama in 1983.
J. Marshall Dodson
Senior Vice President and Chief Financial Officer (44)
J. Marshall Dodson was appointed Senior Vice President and Chief Financial Officer in March
2013 after joining Key Energy as Vice President and Chief Accounting Officer in August, 2005
and being appointed Vice President and Treasurer in June, 2009. Previously, he served as
Managing Director and Controller in Dynegy Generation. He started his career in Arthur
Andersen LLP, Houston, in 1993. That same year, he graduated with a B.B.A. from the
University of Texas at Austin.
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Kim B. Clarke
Senior Vice President: Administration, Administration and Chief People Officer (59)
Kim Clarke was appointed Senior Vice President and Chief People Officer in January 2006.
Before that, she joined Key Energy in November 2004 as Vice President Human Resources
and was promoted to her current position. She has 30 years of managerial experience in
Employee Relations, Compensation, Payroll, Training, and HR Technology at Anderson
Clayton, Baker Hughes, and National Supply. She also serves as a director of ADA‐ES, Inc. She
received a B.S. from the University of Houston.
Jeffrey S Skelly
Senior Vice President: Rig Service (57)
Jeffrey S. Skelly currently serves as Senior Vice President ‐ Rig Services and Operations
Support of Key Energy. He joined Key as its Senior Vice President, Rig Services effective in
June 2010. His previous role was Chief Operating Officer at GEODynamics, a technology
company focused on perforating systems and solutions. Previously, he was President for
Western Hemisphere Operations in Expro Group. Mr. Skelly has also served in various roles at
Halliburton including Global Manufacturing Operations Manager, Global Product Manager for
Logging and Perforating, and Regional Manager of Wireline and Testing for the Middle East.
Mr. Skelly started his career in the oil and gas services business after receiving a B.S. in Civil
Engineering and Ocean Engineering from Florida Institute of Technology. After graduation, he
joined Schlumberger and held various positions over the next 15 years including Field
Engineer, Technical Manager, Field Service Manager, District Manager, Area Operations
Manager, and Sales Manager.
Board of Directors
Currently, Key Energy has 11 members on the Board of Directors, including the Chairman,
two executives, and eight independent directors. The responsibility of the Board is to meet at
least four times a year to review and discuss the reports by the CEO and senior management.
The Board is also responsible for approving or disapproving the strategies and plans proposed
by the management. The shareholders elect the Board of Directors and one‐third of the
directors are reelected every year. The service term for each election is three years.
SHAREHOLDER ANALYSIS
Key Energy Services had 200 million shares authorized, 157,697,732 shares issued, and
153,557,108 shares outstanding at the end of the third quarter of 2015. Shares outstanding
increased by 1.03% between the first and third quarters in 2015.
Institutional Investors
Institutional investors hold the majority of Key Energy’s stock, with 165 institutions holding
about 67% of shares. Recently, institutional investors have decreased their positions in the
Company, reducing their share of ownership by 16.9% in 2016 alone.
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Previously, NWQ Investment Management Co was Key’s second largest institutional investor
but the firm sold its entire position. Dimensional Fund Advisors, Vanguard Group, Citadel,
and Blackrock reduced their holdings by 3.10%, 28.93%, 42.99%, and 40.81%, respectively,
while Citigroup, QS Investors, Van Den Berg, and JPMorgan increased their positions by
2,848.14%, 10.39%, 12.95%, and 3.93%, respectively. According to Morningstar, Citigroup
bought about 4 million shares at the end of September 2015. The high volatility of the oil and
gas stocks leads institutional investors to bet on Key’s stock, explaining the somewhat even
division between institutions increasing and decreasing their positions (see Table 4).
Table 4: Top Ten Institutional Investors
Source: Bloomberg February 3, 2016
Shareholder Position % Ownership
MHR Fund Management LLC 17,484,343 11.10%
Dimensional Fund Advisors LP 8,409,666 5.34%
Blackrock 7,791,933 4.94%
Citadel Advisors LLC 7,350,247 4.66%
JPMorgan Chase & Co 6,143,275 3.90%
Vanguard Group 4,911,277 3.12%
Norges Bank 4,253,822 2.70%
Citigroup Incorporated 4,142,488 2.63%
Van Den Berg Management Inc 4,067,454 2.58%
QS Investors LLC 2,871,612 1.82%
Insider Investors
Key Energy has 21 insider investors currently holding 6.57% of shares, as of February 3, 2016.
In 2016, insiders increased their percentage of shares held from 4.93% to 6.57%. Robert
Drummond, who was named President and Chief Operating Officer (COO) in June 2015, is the
largest insider investor holding 1.66% of shares. Mr. Drummond purchased 2.34 million
shares on 6/22/2015 and 2.96 million shares on 1/29/2016 to become the Company’s largest
insider shareholder. Key’s Chief Executive Officer (CEO) and formerly largest shareholder,
Dick Alario, sold 123,318 shares at the end of January 2016, reducing his position to 1.06% of
shares. The large increase in insider repurchases this year is attributable to a change in
management; because Mr. Alario split his roles of COO and CEO by appointing Drummond to
the former, Drummond significantly invested in the Company’s shares to gain operating
control. All of the insider investor holders are current executives or board members except
Newton W Wilson II, a former Key Energy COO (see Table 5).
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Table 5: Top Insider Investors
Insider Shareholder Relationship
% of Shares
Outstanding
Position
Robert Drummond President/Chief Operating Officer 1.66% 2.62m
Richard J. Alario Chief Executive Officer 1.06% 1.67m
J. Marshall Dodson
Senior VP/Chief Financial
Officer/Treasurer
0.77% 1.21m
Newton W. Wilson III Former Executive 0.41% 0.65m
Jeffrey S. Skelly Senior VP: RIG Services 0.40% 0.63m
Kim B. Clarke Senior VP: Administration 0.38% 0.59m
Scott P. Miller
Senior VP: Operations Services/
Chief Administrative Officer
0.22% 0.34m
Kimberly R. Frye General Counsel 0.18% 0.29m
W. Phillip Marcum Director 0.18% 0.28m
William D. Fertig Director 0.17% 0.27m
Source: Bloomberg February 3, 2016
RISK ANALYSIS AND INVESTMENT CAVEATS
Key Energy faces operational, regulatory, and financial risks in the highly competitive and
cyclical oil and gas service provider industry. The recent impacts of the declining world oil
market and other factors provide additional risks that impact both the daily operations and
the long‐term profitability of the Company.
Operational Risk
Seasonality and Weather Risks
While Key Energy’s revenues are somewhat seasonal, severe weather has a more impactful
risk on the Company’s operations. Hurricanes and tropical storms in the gulf region reduce
the demand for Key’s services, damage the Company’s facilities and equipment, and interfere
with the Company’s ability to deliver equipment to contracted job sites. Additionally, the
delay of its customers’ and clients’ operations negatively impact Key.
Threat of Competition
A significant risk to Key’s operations is the intense threat of competition. Key’s top ten
customers accounted for 47% of the Company’s revenue in 2014; the loss of one of these
large customers to a competitor would significantly diminish Key’s revenues. The loss of large
clients is a current risk for Key as the weak market makes the industry increasingly price
competitive. The poor oil market conditions prevent Key from generating sufficient revenue
to operate to its full potential so a further loss of cash flow would be detrimental to the
Company’s operations.
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Oil Price Volatility
In addition to increasing industry‐wide competition, the oil price volatility directly affects
Key’s operations. Oil prices are highly volatile, experiencing natural and gradual fluctuations.
However, the recent oil crisis has driven prices to a low point with no realistic improvement
in the near future, halting operations for all types of oil and gas companies. Thus, customers
are no longer contracting Key’s services. The risk of oil price volatility is only worsening as the
market declines.
Labor Risk
Key operates in a capital‐intensive industry, which requires the Company to employ a large,
highly skilled workforce. The labor risk for the Company involves the large expense of
employing such a workforce as well as the lack of availability of good employees. Key has
historically experienced high employee turnover rates because finding skilled employees is
difficult as is paying these workers a fair wage. Another labor risk for Key is the liability of
employees who perform dangerous jobs and operate large equipment.
Environmental Risks
Many environmental issues arise in the oil and gas industry. Because Key is a service provider,
many environmental risks are lessened; however, the Company’s customers could be more
exposed to these risks and potentially impact Key’s operations. Additionally, the risk of new
environmental regulations could impact Key.
Liability Risks and Credibility Risks
A substantial risk for Key is its liabilities. Key faces the risk of customers defaulting on
payments, defaulting on its own debt, paying employees for work related injuries and
damages, and losing valuable equipment due to extreme weather or operational accidents.
Additionally, Key is facing issues with its credibility because of its extremely low stock price
and the risk of being downgraded.
Capital Risk
Key faces capital risks because the industry requires significant capital investments and the
Company will be unable to compete if revenues remain low. Key’s larger competitors have
more financial resources and bargaining power and can still invest in new technology and
developments when Key cannot, giving the larger companies a huge competitive advantage
as well as reducing these competitors’ capital risk.
Investment Risk
Key faces great investment risks. Due to unsuccessful operations and failed foreign ventures,
Key decided to sell off its international segment and try to relocate equipment. Thus far, Key
has impaired the value of many of its assets and sold its foreign subsidiaries at a loss.
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These losses negatively impacted Key’s operations and will prevent the Company from
making positive investments in the future. Additionally, a primary technology for Key is the
KeyView system. The failure of this technology presents another large investment risk for the
Company.
Debt Risk
In addition to large impairments, the Company has taken on more debt in the first three
quarters of 2015 than it has over the past five years. The increased level of debt signals an
increased risk for Key.
Financial Risk
Capital Funding Risk
Key Energy operates in a capital‐intensive industry. Key’s ability to raise debt or equity for
financing depends on the condition of capital markets and the Company’s financial condition.
Since 2013, Key Energy has been suffering from negative income. In the first and second
quarter of 2015, Key has generated $305,550,000 debt for financing. The newly raised debt
increases the Company’s debt‐to equity ratio from 1.2 to 4.1, significantly lowering the
Company’s solvency. These financial conditions may lower investor’s willingness to lend Key
more money unless Key pays a higher interest rate. As a result, Key Energy may have a hard
time raising sufficient capital for future operation and development.
Solvency Risk
Key Energy has had negative income since 2013 and negative operating cash flow during the
first three quarters of 2015. At the same time, Key raised a large amount of long‐term debt of
$305,550,000 during the first two quarters of 2015. As mentioned above, Key’s solvency
lowered because of this new borrowing. A debt of $787,000 was paid at the end of 2015 and
a $3,150,000 debt will be due by the end of 2016. If Key cannot generate sufficient cash flow
from operation by that time, it will likely repay these debts with new debts. Additionally,
there will be $978,975,000 debt due in 2019. If Key can not generate sufficient cash by that
time, it will be unable to pay off the large amount of debt. This financial condition, and Key’s
recent poor performance in the income statement, significantly increases the possibility of
bankruptcy for the Company. Therefore, the solvency risk for Key Energy is higher than the
past few years.
Impairment Risk
Key records goodwill and asset impairment charges. The Company periodically evaluates its
long‐lived assets. Significant impairment loss can occur during these evaluations when the
Company finds that the future cash flow generated with assets differs largely from its original
estimation. By the end of the third quarter of 2015, Key recorded an impairment loss in
goodwill of $582,739,000.
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Regulatory Risk
Climate Change Regulations
Various state governments are considering enacting new regulations governing or restricting
the emission of greenhouse gases from stationary sources, which may include Key Energy’s
equipment and operations. These new regulations associated with climate change can
increase Key Energy’s operating costs.
Cost from Environmental, Health, and Safety Laws
Key Energy’s operations are subject to U.S. federal, state, local, and foreign laws and
regulations that establish standards of the handling, storage, and disposal of waste materials.
Complying with these laws can result in higher costs in Key’s operation. In addition, operating
in the oil industry poses the risks of environmental liability, like fluid leakage from operation
to the surface of the soil or water. Some laws impose strict or joint liability, which means that
Key can be liable for the pollution caused by other companies operating in nearby areas.
FINANCIAL PERFORMANCE AND PROJECTIONS
Key Energy's financial performance is suffering from depressed commodity prices. A
stronger, more liquid position and continued cost saving activities will allow Key Energy to
survive until oil prices recover.
Operating Activities
Key Energy’s revenues depend on the Company’s rig hours. We used a multiple regression
model to forecast revenues for the next two years. We incorporated a main external revenue
driver and several significant events that could make the model less predictive, such as
economic crisis and weather events. Our main revenue driver is the Baker Hughes U.S. Land‐
Based quarterly Rig Count. Although the collapse of rig counts has dragged down U.S.
production, Key’s maintenance service segment, which pertains to existing wells, could
become a new revenue generator for the Company during the delay of new drilling activities.
We expect rig counts to increase as oil prices recover in the next two years. For further
forecasts, we applied a perpetual growth rate that represents Key Energy’s growth potential
in a period with more favorable oil prices.
We forecasted the Company’s expenses based on how it historically operated. Main expenses
for Key Energy include direct operating expenses, depreciation and amortization expenses,
and general and administrative expenses. In projecting direct operating expenses and general
and administrative expenses, we calculated the historic average percentage of the expenses
relative to revenue. We then multiplied the period’s forecasted revenue by these
percentages. Direct operating expense is approximately 70% of revenue. General
administrative expense is approximately 16% of revenue. We estimated depreciation by
comparing the average percentage of depreciation expense to the average property, plant,
and equipment (PPE) based on historic data.
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Our forecasts indicate that PPE will decrease in 2016 because of reduced capital expenditures
resulting from the low oil price. After 2016, PPE will gradually rise as the oil prices improve.
We projected amortization expense using the Company’s amortization schedule in its
financial report. According to the report, current amortizable assets will shrink to zero after
2019.
Financing and Investing Activities
We forecasted new long‐term debt due in 2021 because of the large amount of new debt Key
borrowed during its 2015 refinancing. According to the Company’s annual report, Key plans
to pay‐off this newly issued debt by 2019. While we think currently low oil prices and Key’s
revenue will rise jointly in the near future, we doubt the Company’s ability to pay‐off this
debt by 2019. Key will start to generate positive cash flow as prices improve, but only enough
to allow the Company to gradually pay‐off the debt. Key has such a large amount of debt that
will require the Company to find additional financing to support its ever‐increasing capital
expenditures, especially as the industry recovers and becomes more competitive.
SITE VISIT
On Friday, February 19, 2016, our analyst team visited Key Energy’s corporate headquarters
in Houston, Texas. Our team met with Robert Drummond, Key’s Chief Operating Officer, J.
Marshall Dodson, Chief Financial Officer, and West P. Gotcher, Director of Investor Relations.
After a brief introduction to the Company and the management team, the executives
answered many of our questions.
Mr. Drummond first pointed out that the most important thing for the Company’s current
operations is to reduce costs, especially regarding labor, by restructuring its service offerings.
He compared compensation costs of Key Energy, as well as other oil field service companies,
with that of its customers, oil production companies, and believed they took necessary
measures for surviving during unfavorable market conditions. Moreover, cutting costs is a
long‐term goal that Key Energy strives to achieve as it results in significant improvements in
the Company's efficiency, competitiveness, and profitability.
When questioned about the reverse stock split plan, Mr. Drummond mentioned that it must
be implemented at the most appropriate time. All the shareholders of Key Energy will vote on
the plan in November if the Company still needs to regain compliance with listing
requirement at that time.
Mr. Dodson clarified that the misstep of Key’s international expansion was caused by
numerous factors. The venture was no longer economically feasible due to the combination
of unexpectedly low returns from international business segments and the many risks
involved in operating outside of the U.S. As such, he positioned Key Energy as a niche player
focusing on North American market.
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He also thinks the oil market needs a better organized cartel rather than having the goal of a
free market, in part because international oil has never functioned in a free market
environment. In terms of U.S. oilfield service providers, Professor Smith believes that oilfield
services providers’ key issue is how to preserve the core of operations until the oil price
environment turns around. The problem is how to maintain the major products and services
these companies provide, as well as how to maintain a qualified workforce.
We also interviewed John S. Foreman III from the Tulane University Energy Institute. Mr.
Foreman is the Oil and Gas Marketing Manager of PetroQuest Energy Inc., a publicly traded,
independent exploration and production company headquartered in Lafayette, Louisiana.
Mr. Foreman explained that low oil prices are expected to remain throughout 2016, while the
key point is whether the Organization of the Petroleum Exporting Countries (OPEC) and non‐
OPEC members can reach an agreement. U.S. and European Union sanctions were lifted
against Iran, restoring its access to the world markets. Mr. Foreman explained that it’s not
likely that Iran could cut production because Iran is trying to regain energy market share and
the agreement between OPEC members and non‐OPEC members is unlikely to occur.
Production should remain on a high level in the near term. As a result, Key Energy is expected
to struggle throughout 2016. Mr. Foreman advised Key Energy to seek out potential
opportunities in Iran or elsewhere in the Middle East.
During the conversations with professional analysts, the issue of liquidity is the primary
concern for Key Energy. The Company uses its equipment as a collateral for outstanding debt
and to issue debt, which is also known as an asset backed security. The amount of debt that
Key Energy can get is directly associated with the capacity of the equipment to generate
revenue. Under the current downward market pressure, the amount of debt that Key Energy
can keep or get is unpromising. Analysts recommended that when looking at how Key Energy
will perform in the year 2016, our team should focus on how well the management of Key
Energy can manage its existing debt covenants.
In terms of Key Energy’s competitiveness, analysts think in the short term it depends on how
it will get out of a cycle of “suicidal‐type bidding wars” during this prolonged slump and how
to avoid being forced out of business. In the long term, since Key Energy is a derivative
company in the oil and gas production process, the ultimate question is still how much of the
customers’ budget will Key capture when exploration and production (E&P) companies enter
a new boom cycle.
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ANOTHER WAY TO LOOK AT IT
ALTMAN Z‐SCORE
The Altman Z‐Score measures the risk of a company going into bankruptcy. The formula
incorporates a weighted average of working capital, retained earnings, earnings before
interest and taxes (EBIT), and sales as a percentage of a company's total assets, along with a
company's market value of equity per total liabilities. A company with a Z‐Score above 3.0 is
considered to be safe with a low risk for bankruptcy. If a company has a Z‐Score of 1.80 to 2.7,
the company is considered to have a moderate risk of default. However, a company with a Z‐
Score that is lower than 1.80 is generally is said to have a high risk of default.
In the case of Key Energy, the Company currently has an Altman Z‐Score of (2.54). Over the
past four years, Key has been at a high risk of default. While Key Energy is not a
manufacturing company and does fit within the original parameters of the Z‐Score analysis,
the reason behind the (2.54) Z‐Score in 2015 is the huge loss of EBIT and the low level of
working capital (see Figure 5).
Figure 5: Key’s Z Score
3.17
2.06
1.59
2.18 2.20
1.93
1.77 0.61
-2.54-3.00
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
2007 2008 2009 2010 2011 2012 2013 2014 2015
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WWBD?
What Would Ben (Graham) Do?
Ben Graham, often considered the father of value investing, created a ten‐point plan to
evaluate the attractiveness of an individual stock. Our method is modified, as we are only
considering eight out of ten hurdles to evaluate a company. If a company and its share price
could overcome four of Mr. Graham’s eight hurdles, then he considered the stock attractive.
The hurdles we analyzed are as follows
1. An earnings to price yield of 2x the Yield on ten‐year Treasury
2. A price to earnings (P/E) ratio down to one‐half of the stock’s highest in five years
3. A dividend yield of one‐half the yield on ten‐year Treasury
4. A stock price less than 1.5 book value (BV)
5. Total debt is less than book value
6. Current ratio of two or more
7. Earnings growth of 7% or higher over the past five years
8. Stability in growth of earnings
After calculating these hurdles, Key Energy only passed three out of eight hurdles.
Figure 7: Ben Graham Dial
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Earnings per share (ttm) (5.86)$ Price: 1/0/1900
Earnings to Price Yield ‐1362.79%
10 Year Treasury (2X) 3.98%
P/E ratio as of 12/31/11 57.7
P/E ratio as of 12/31/12 75.4
P/E ratio as of 12/31/13 (98.8)
P/E ratio as of 12/31/14 (4.9)
P/E ratio as of 12/31/15 (0.1)
Current P/E Ratio
Dividends per share (ttm) ‐$ Price: 0.43$
Dividend Yield 0
1/2 Yield on 10 Year Treasury 0.99%
Stock Price 0.43$
Book Value per share as of 12/31/15 0.90$
150% of book Value per share as of 12/31/15 1.35$
Interest‐bearing debt as of 12/31/15 964,850$
Book value as of 12/31/15 140,290$
Current assets as of 12/31/15 420,426$
Current liabilities as of 12/31/15 154,483$
Current ratio as of 12/31/15 2.72
EPS for year ended 12/31/11 0.69$
EPS for year ended 12/31/12 0.05$
EPS for year ended 12/31/13 (0.14)$
EPS for year ended 12/31/14 (1.16)$
EPS for year ended 12/31/15 (5.86)$
EPS for year ended 12/31/11 0.69$ 1280%
EPS for year ended 12/31/12 0.05$ ‐136%
EPS for year ended 12/31/13 (0.14)$ ‐88%
EPS for year ended 12/31/14 (1.16)$ ‐80%
EPS for year ended 12/31/15 (5.86)$
Stock price data as of M arch 16, 2016
Hurdle # 7: Earnings Growth of 7% or Higher over past 5 years
No
Hurdle # 8: Stability in Growth of Earnings
No
No
Hurdle # 4: A Stock Price less than 1.5 BV
Yes
Hurdle # 5: Total Debt less than Book Value
Hurdle # 6: Current Ratio of Two or More
Yes
Hurdle # 3: A Dividend Yield of 1/2 the Yield on 10 Year Treasury
No
KEY ENERGY SERVICES INC. (KEG)
Ben Graham Analysis
Hurdle # 1: An Earnings to Price Yield of 2X the Yield on 10 Year Treasury
No
Hurdle # 2: A P/E Ratio Down to 1/2 of the Stocks Highest in 5 Yrs
No
29. Key Energy Services Inc. (KEG) BURKENROAD REPORTS (www.burkenroad.org)March 16, 2016
29
KEY ENERGY SERVICES INC. (KEG)
Annual and Quarterly Earnings
In thousands
5For the period ended2013 A2014 A2015 A31‐Mar E30‐Jun E30‐Sep E31‐Dec E2016 E31‐Mar E30‐Jun E30‐Sep E31‐Dec E2017 E
Revenues:
Total revenues1,591,676$ 1,427,336$ 792,326$ 129,996$ 134,060$ 138,124$ 142,188$ 544,366$ 151,670$ 161,153$ 174,699$ 188,246$ 675,768$
Costs and expenses:
Direct operating expenses1,114,462 1,059,651 714,637 91,580 95,750 103,065 99,406 389,800 106,850 115,101 130,357 131,606 483,913
Depreciation and amortization expense225,297 200,738 180,271 47,615 46,805 46,038 45,286 185,745 44,356 43,624 42,920 42,231 173,130
General and administrative expenses221,753 249,646 202,631 21,028 21,403 22,220 22,460 87,111 24,534 25,728 28,104 29,736 108,102
Interest expense, net of amounts capitalized55,204 54,227 73,847 19,156 19,156 19,156 19,156 76,622 19,156 19,156 19,156 19,156 76,622
Other, net(803) 1,009 9,394
Total costs and expenses, net1,615,913 1,686,447 1,902,876 179,379 183,114 190,477 186,308 739,278 194,895 203,609 220,536 222,728 841,767
Income before income taxes and noncontrolling interest(24,237) (259,111) (1,110,550) (49,383) (49,054) (52,354) (44,120) (194,912) (43,225) (42,456) (45,836) (34,482) (165,999)
Income tax expense3,064 80,483 192,849 17,778 17,660 18,847 15,883 70,168 15,561 15,284 16,501 12,414 59,760
Net (Loss) Income from continuing operations(21,173) (178,628) (917,701) (31,605) (31,395) (33,506) (28,237) (124,744) (27,664) (27,172) (29,335) (22,069) (106,239)
Net (Loss) Income(21,173) (178,628) (917,701) (31,605) (31,395) (33,506) (28,237) (124,744) (27,664) (27,172) (29,335) (22,069) (106,239)
Noncontrolling interest595
(Loss) Income Attributable to Common Stockholders(21,768)$ (178,628)$ (917,701)$ (31,605)$ (31,395)$ (33,506)$ (28,237)$ (124,744)$ (27,664)$ (27,172)$ (29,335)$ (22,069)$ (106,239)$
Income per common share from continuing operations excluding loss from debt extinguishment:
Basic(0.14)$ (1.16)$ (5.86)$ (0.20)$ (0.19)$ (0.19)$ (0.16)$ (0.73)$ (0.15)$ (0.14)$ (0.15)$ (0.11)$ (0.55)$
Diluted(0.14)$ (1.16)$ (5.86)$ (0.20)$ (0.19)$ (0.19)$ (0.16)$ (0.73)$ (0.15)$ (0.14)$ (0.15)$ (0.11)$ (0.55)$
Net income per common share
Basic(0.14)$ (1.16)$ (5.86)$ (0.20)$ (1.84)$ (1.90)$ (1.55)$ (6.85)$ (1.47)$ (1.40)$ (1.47)$ (1.07)$ (5.17)$
Diluted(0.14)$ (1.16)$ (5.86)$ (0.20)$ (0.19)$ (0.19)$ (0.16)$ (0.73)$ (0.15)$ (0.14)$ (0.15)$ (0.11)$ (0.55)$
Net income per common share excluding non‐recurring items
Basic(0.14)$ (1.16)$ (5.86)$ (0.20)$ (0.19)$ (0.19)$ (0.16)$ (0.73)$ (0.15)$ (0.14)$ (0.15)$ (0.11)$ (0.55)$
Diluted(0.14)$ (1.16)$ (5.86)$ (0.20)$ (0.19)$ (0.19)$ (0.16)$ (0.73)$ (0.15)$ (0.14)$ (0.15)$ (0.11)$ (0.55)$
Weighted average common shares outstanding:
Basic152,271 153,371 156,598 160,876 167,153 173,279 179,261 169,958 185,106 190,883 196,660 202,438 193,772
Diluted152,271 153,371 156,598 160,876 167,153 173,279 179,261 169,958 185,106 190,883 196,660 202,438 193,772
SELECTED COMMON‐SIZE AMOUNTS (% of total revenues unless otherwise noted)
Costs and expenses:
Direct operating expenses70.02%74.24%69.65%70.45%71.42%74.62%69.91%69.65%70.45%71.42%74.62%69.91%69.65%
Depreciation and amortization expense14.15%14.06%12.04%13.07%14.28%14.67%12.24%12.04%13.07%14.28%14.67%12.24%12.04%
General and administrative expenses13.93%17.49%14.65%16.18%15.97%16.09%15.80%14.65%16.18%15.97%16.09%15.80%14.65%
Total costs and expenses, net101.52%118.15%240.16%137.99%136.59%137.90%131.03%135.81%128.50%126.35%126.24%118.32%124.56%
(Loss) Income Attributable to Common Stockholders‐1.37%‐12.51%‐0.33%‐5.97%‐7.05%‐75.83%2.89%‐0.33%‐5.97%‐7.05%‐75.83%2.89%‐0.33%
SELECTED YEAR TO YEAR CHANGES
Total revenues‐18.79%‐10.32%‐44.49%‐51.46%‐32.12%‐21.90%‐5.32%‐31.30%16.67%20.21%26.48%32.39%24.14%
Costs and expenses:
Direct operating expenses‐14.85%‐4.92%‐32.56%‐55.22%‐39.72%‐40.94%‐43.76%‐45.45%16.67%20.21%26.48%32.39%24.14%
Depreciation and amortization expense5.39%‐10.90%‐10.20%0.86%1.98%1.70%8.10%3.04%‐6.85%‐6.80%‐6.77%‐6.75%‐6.79%
General and administrative expenses‐3.79%12.58%‐18.83%‐68.91%‐57.79%‐50.97%‐42.35%‐57.01%16.67%20.21%26.48%32.39%24.10%
Interest expense, net of amounts capitalized3.06%‐1.77%36.18%43.57%12.30%‐11.74%‐11.90%3.76%0.00%0.00%0.00%0.00%0.00%
Total costs and expenses, net‐10.23%4.36%12.83%‐50.01%‐37.63%‐79.79%‐39.46%‐61.15%8.65%11.19%15.78%19.55%13.86%
(Loss) Income Attributable to Common Stockholders‐385.59%720.60%413.75%‐47.04%‐51.98%‐94.77%‐81.48%‐86.41%‐12.47%‐13.45%‐12.45%‐21.85%‐14.83%
2017 E2016 E
