Precision Drilling Corporation (PDS) Q3 2023 Earnings Call Transcript

Precision Drilling Corporation (NYSE:PDS) Q3 2023 Earnings Conference Call October 26, 2023 2:00 PM ET

Company Participants

Lavonne Zdunich – Director of Investor Relations

Carey Ford – Senior Vice President & Chief Financial Officer

Kevin Neveu – President & Chief Executive Officer

Conference Call Participants

Aaron MacNeil – TD Cowen

Luke Lemoine – Piper Stanley

Kurt Hallead – Benchmark

Keith Mackey – RBC Capital Markets

Cole Pereira – Stifel

Waqar Syed – ATB Capital Markets

Sean Mitchell – Daniel Energy Partners

Operator

Good day, and thank you for standing by. Welcome to the Precision Drilling Corporation 2023 Third Quarter Conference Call.

I would like to hand the conference over to Lavonne Zdunich, Director of Investor Relations. Please go ahead.

Lavonne Zdunich

Welcome to Precision’s third quarter earnings conference call and webcast. Participating on today’s call with me will be Kevin Neveu, President and CEO; and Carey Ford, our CFO.

Earlier this morning, Precision reported strong third quarter results, which Carey will review with you, followed by an operational update and outlook commentary from Kevin. Once we have finished our prepared comments, we will open the call to questions.

Some of our comments today will refer to non-IFRS financial measures and will include forward-looking statements, which are subject to a number of risks and uncertainties. Please see our news release and other regulatory filings for more information on financial measures, forward-looking statements and risk factors. As a reminder, we express our financial results in Canadian dollars unless otherwise indicated.

Before I pass the call over to Kevin and Carey, I would like to remind listeners of our CWC Energy Services acquisition, which we announced in early September. This acquisition will position Precision as the premier well service provider in Canada and bolster our drilling operations in both the US and Canada. With the acquisition, Precision adds to its marketed fleet 62 service rigs and seven drilling rigs in Canada, plus 11 drilling rigs in the US, which includes seven AC Triples. We expect this acquisition to close within the next couple of weeks and generate accretive cash flow on a per share basis in 2024.

With that, I’ll pass it over to Carey.

Carey Ford

Thanks, Lavonne. Precision’s Q3 financial results reflect the resiliency of our high-performance, high-value business model and organizational focus on cash flow and return on capital, meeting our expectations for adjusted EBITDA and further strengthen our balance sheet.

During the quarter, adjusted EBITDA of CAD 115 million was driven by multi-drilling activity, improved pricing and strict cost control and included a share-based compensation charge of CAD 31 million. Without this charge, adjusted EBITDA would have been CAD 146 million, which compares to normalized EBITDA of CAD 126 million in Q3 2022, an increase of 16%.

Margins in Canada were higher than guidance, resulting from stronger-than-expected pricing and cost recoveries, higher ancillary revenues and improved cost performance. In the US, margins were lower than guidance, largely due to an increase in operating costs, driven by increased repair and maintenance costs and lower fixed cost absorption, as we’re maintaining higher overhead in anticipation of increased activity in the first part of 2024.

In the US, drilling activity for Precision averaged 41 rigs in Q3, a decrease in 10 rigs from Q2. Daily operating margins in Q3, excluding the impact of turnkey and IBC were US$11,941, a decrease of US$1,563 from Q2. For Q4, we expect margins, excluding the impact of turnkey and IBC to be in line with Q3 margins in the US$11,500 to US$12,000 range.

In Canada, drilling activity for Precision averaged 57 rigs, a slight decrease in two rigs from Q3 2022. Daily operating margins in the quarter were CAD 13,913, an increase CAD 1,830 from Q2 2023. For Q4, our daily operating margins are expected to average over CAD 15,000, an increase of CAD 1,000 from Q3 levels due to ancillary winter equipment and improving pricing.

We continue to build our North American contract book with Q4 2023 drilling rigs of 57 under take-or-pay term contracts on average for the fourth quarter of 2023. In addition, we recently signed several term contracts we were commencing early in 2024.

Internationally, drilling activity for Precision in the quarter averaged six rigs. International average day rates were US$51,570, an increase of 3% from the prior year due to rig mix. We recently activated our fourth rig in Kuwait and expect the fifth rig will be activated in the next few weeks. We expect earnings in our international business to increase approximately 50% from 2023 to 2024.

Moving to our C&P segment. Adjusted EBITDA this quarter was CAD14 million, down slightly compared to the prior year quarter with 10% fewer well servicing hours offset by higher pricing and margins.

Moving to the balance sheet. We are committed to reducing debt by over CAD500 million between 2022 and 2025 and achieving a normalized leverage level of below one time. Our debt reduction target for 2023 is CAD150 million, and we plan to allocate 10% to 20% of free cash flow before principal payments directly to shareholders.

During the quarter, we reduced debt by CAD26 million and have now reduced debt by CAD126 million year-to-date. Upon closing the CWC acquisition, we will assume CWC debt at cash payments to CWC shareholders and incurred transaction costs, all totaling in the CAD60 million to CAD70 million range. Despite incurring cash costs, we still expect to meet our annual debt reduction target of CAD150 million pointing to robust cash flow expectations in the fourth quarter.

As of September 30, our long-term debt position, net of cash, was approximately CAD915 million, and our total liquidity position was CAD621 million, excluding letters of credit. Our net debt to trailing 12-month EBITDA ratio was approximately 1.7 times, and our average cost of debt is approximately 7%. We expect our net debt to adjusted EBITDA ratio to be below 1.5 times by year-end with net debt of approximately CAD900 million and our run rate interest expense of approximately CAD65 million.

Our full year 2023 capital plan has increased from CAD195 million to CAD215 million, largely a result of signing term contracts with upgrade capital paid back inside of the term of the contract. For several of these contracts, we received cash upfront from the customer. Additional annual guidance for 2023, which does not consider impacts from the CWC acquisition includes depreciation at CAD290 million and SG&A of CAD90 million before share-based compensation expense.

We expect cash interest expense to be approximately CAD80 million for the year and cash taxes to remain low with an effective tax rate of approximately 25%. Year-to-date, we have had share-based compensation charges of CAD22 million. As previously stated, we expect our 2023 share-based compensation expense to range between CAD20 million and CAD40 million for the share price range of CAD60 to CAD100 with the potential to increase or decrease another CAD15 million based upon relative share price performance and a multiple between zero and two times.

With that, I will now turn the call over to Kevin.

Kevin Neveu

Thank you, Carey, and good afternoon. I’m pleased with our third quarter results with improved revenue and cash flow compared to the same period last year despite lower industry activity in our North American markets. I commend everyone in Precision’s organization for their precise execution and safety, excellent operational performance, strict financial discipline and the continued focus on cash management, which was demonstrated across all Precision business segments during the quarter.

I continue to be very encouraged by the support of commodity price on metals, but also by the strict capital discipline evident across this industry. And this discipline begins with the investors’ expectations for shareholder returns and a continued assistance for industry capital discipline.

Our customers are functioning very well in this environment. They are not responding to short-term commodity price signals or volatility. We are managing budgets and staying well within cash flow, and most importantly, focusing on efficiency and performance.

And nowhere is this more important than our Canadian segment, where broad industry activity is down 6% during the third quarter compared to last year as our customers remain highly disciplined, staying within fixed budgets.

Yet our 29 Super Triple rigs are fully utilized this year compared to 25 at the same time last year, and I remind you, we’ll be adding one more Super Triple to our fleet on January 1st through an upgrade we announced late last year. Today, we’re also running 32 Super Singles, and this would be the highest Q3 utilization of this rig class since early last decade.

In light of the high super spec rig demand, we have customers anxious to commit to firm take-or-pay term contracts, securing rig access. Currently, our Canadian book includes 27 rigs under term contracts and 17 of those have two-year-plus terms. I’ll remind you that the Canadian market term take-or-pay contracts were traditionally exceedingly rare.

Notably, we recently booked several customer contracts, which include pad walking and depth extending upgrades. And those rigs are required for the winter 2024 drilling season, and this necessitated increasing our current year capital budget as Carey described earlier.

I’ll also reiterate Carey’s comments that the capital will pay back within the contract period, and the enhanced margins will continue for the duration of the rigs operational life. Also for several of these contracts, customers provided us with advanced cash payments upfront as we work hard to minimize our cash outflows.

Our outlook for Canada remains uniquely strong. Early in 2024, two major hydrocarbon pipe projects will be started up. The Coastal GasLink pipe set to deliver natural gas to the LNG Canada project, and Trans Mountain expansion, adding almost 700,000 barrels per day of oil export capacity.

For Canada, these projects are absolute game changers resulting in significantly improved upstream commodity prices for our customers, debottlenecking production and providing global market access for Canadian energy.

Now I see these independent projects as complementing each other. And that is to say that the liquid condensate produced by the Montney gas wells is sold commercially as diluent to the heavy oil producers to enable heavy oil shipping to pipelines. So this significantly improves the economics of the Montney gas producers who are ultimately focused on the LNG exports over the longer term.

Concurrently, the increased oil export capacity of TMX will serve to reduce the Western Canada Select price discount, significantly improving economics for our heavy oil customers. So for Precision, the result is that the natural gas drilling in the Montney is growing to meet the imminent needs of LNG Canada and heavy oil drilling has rebounded to levels not experienced since 2014. And all of this is evidenced in our record Super Triple demand and our strong Super Single demand.

So this is truly a game changer for Precision’s Canadian drilling market with term contracts providing revenue stability, reduced seasonality with pad rigs drilling throughout breakup, market visibility extending beyond seasonal commodity price volatility and all of these factors setting us up to deliver sustainable shareholder returns commensurate with our asset base and providing opportunities for further expansion in our Canadian footprint.

Today, we have 68 rigs running, actually up one from our press release, which was reporting yesterday’s activity and expect to be in the low 70s before the Christmas pause.

Customer planning for winter suggests a strong and fast start to 2024, with customer demand exceeding 23 levels, and we look forward to the addition of the CWC drilling rigs improves and we expect that Precision’s combined activity this winter could be up 10% to 15% from last year.

Leading yet day rates for our Super Triples are now in the mid-30s and for our conventional super singles in the mid-20s while our code-quip super singles have now moved up into the low CAD30,000s per day in range.

In particular, excess customer demand for Precision’s alpha equipped Super Triple rigs is seemingly in the range of 7 to 10 additional rig opportunities we’re considering. I think the likelihood that we secure a customer pay redeployment of at least 1 or 2 Super Triples in the US to Canada later next year is increasing.

With our Super Singles, the demand tends to be more seasonal with winter being the peak season where demand could outstrip our rig availability by 10 or more rigs. So we expect these market demand signals may lead to additional opportunities for customer-funded upgrades for pad drilling and longer-reach horizontal capabilities and certainly stimulate further customer interest in take or pay term contracts so they can secure access to the rigs.

Now turning to the Lower 48. The capital discipline I’ve described in Canada is at work in every US basin. In the near term, it’s meant that natural gas drilling has slowed down over the course of 2023 and the increases in oil targeted drilling we expected earlier this year have failed to materialize as our customers continue to tightly manage their drilling budgets. However, we continue to see customers optimizing drilling efficiency by high-grading rigs, focusing on pad drilling and extending lateral lengths. This focus on efficiency is also continuing to drive customer interest in our Alfa automation platform, our Alfa apps and is driving interest in our evergreen best battery energy storage systems and other diesel fuel savings solutions.

Today, we have 44 rigs operating in the U.S. and seem to be in the trough. Customer indications and interest indicate an increase in activity as budgets reload for 2024, and we expect to see some of these rigs activated later this year.

During the third quarter, we continued to experience strong customer interest in our Alpha Super Triple rigs. Since the beginning of the year, we’ve added 5 public E&Ps to our customer list, and increased our share with two others as we transition to more oil-based work and less private company exposure.

Now Super Spec rig supply remains in tight availability. During the third quarter, we secured a paid upgrade commitment from a customer to cover the cost of increasing the horizontal depth capability of Precision Super Triple. And during the year, we’ve executed 12 other similar upgrades.

And these upgrades include enhancements to the non-pumping capability, the drill pipe racking capacity and targeting longer [indiscernible] wells. And some of these also include evergreen enhancements to improve the fuel efficiency of the rig. We expect to see more of these customer upgrades emerging in 2024.

Rig pricing and [indiscernible] rates remained stable as the most capable high-specification rigs remain a tight supply and pricing discipline remains a core strategy across the super-spec land market industry.

I’m very excited to add the 8 CWC rigs and crews currently operating in Wyoming. We see the Powder River Basin as an excellent opportunity for Precision to expand our U.S. operations in 2024.

Now turning to our international business. As Terry mentioned, we activated our fourth rig in Kuwait during the third quarter and expect the fifth rig to start up early to mid-November. Both rigs are activating several weeks later than we previously guided and these delays were entirely due to client planning delays, not Precision issues.

The capital spending to reactive those rigs is largely complete, and the five-year contract for each rig will commence when the rig begins operations.

By mid-November, we’ll have all five rigs in Kuwait operating and three rigs in Kingdom of Saudi Arabia running for total eight rigs, and we’ll continue to bid all five idle rigs to opportunities across [indiscernible]

In our well servicing segment, Canadian industry well servicing activity noticeably slowed during the third quarter as our customers adjusted the cost increases related to services inflation, labor costs, and material costs. We see a backlog of previously planned activity building up and are helping to see a significant increase in activity and expect this to continue in the next year.

I’m also very encouraged by the strong performance we see in the CWC, well services group and look forward to integrating the people of CWC and their operations into our business later this quarter.

So, to wrap-up my comments today, I’m thrilled despite a weaker market than most would have expected, Precision is on track on all three strategic priorities. We also created the financial flexibility to execute a meaningful Canadian consolidation transaction, and we continue to have the flexibility to invest in our fleet to meet customer-backed rig upgrade opportunities.

And with that, I’ll now turn the call back to the operator for your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]

Our first question comes from Aaron MacNeil with TD Cowen. Your line is open.

Aaron MacNeil

Afternoon and thanks for taking my questions. Kevin, I can appreciate that there’s a lot of value in keeping your promises on the debt reduction, especially in light of the track record over multiple years. But sort of putting that aside, how does debt reduction compete today for capital with the NCIB given the prevailing valuation? How should we think about that in the context of your strategic priorities for next year?

Kevin Neveu

Yes. Go ahead, Carey.

Carey Ford

So, I’ll take that one. The debt reduction still remains front and center, and we’ve put out very specific targets for 2023 and then the two years following this year. So we’re committed to doing that.

As we have more free cash flow, we should be able to expand the amount that we allocate towards share repurchases. This year, it’s 10% to 20% of our free cash flow, which would put it kind of in the $15 million to $30 million range of share repurchases. Next year, if our cash flow outlook improves, we should be able to increase that.

Aaron MacNeil

Got it. And Carey, I know you gave guidance for Q4 margins in the U.S. in your prepared remarks, but I’m hoping you can sort of give us a better sense of the moving parts? I mean you mentioned the higher staffing levels. You mentioned R&M, — like how much of that was — I don’t want to call it onetime, but maybe abnormal and what sort of recurring?

Carey Ford

Yes. So, I think if you think about Q3 and Q4, topline, there won’t be a whole lot of movement and the costs that we incurred in Q3, a lot of those will repeat in Q4. So that goes into the margin guidance that we provided. As Kevin mentioned on our Q2 call, we were going to have the rig count kind of moving up and down a little bit around this kind of low 40s level and that means there’s a bit more rig churn than we typically have, which causes a little bit more cost. And as I mentioned, we’re carrying a bit more overhead than we typically with this activity level because we do think that activity is going to increase. But for your guidance, I would point to a similar operating cost in Q4 than we had Q3.

Aaron MacNeil

Got it. Okay. Thanks. I’ll turn it back.

Kevin Neveu

Okay Sherry [ph]

Operator

Our next question comes from Luke Lemoine with Piper Stanley. Your line is open.

Luke Lemoine

Hey, good afternoon. Kevin, I believe you talked about 7 to 10 additional opportunities again and maybe you can move one to two US Super Triples into Canada. When you’re looking at opportunities like that, are these kind of two-year terms that you’re targeting to make the move from the US to Canada? Or how are you thinking about that?

Kevin Neveu

Luke, that’s a great question, it’s a real important strategy question for us as we think about it. And some of these opportunities might not be for full year work. It might be for the winter or maybe for the summer. So we’ll look at that very carefully and determine what we think is best. What we look for, though, number one, is that the operator needs to be paying a leading-edge market rate. In the past talked about that being around CAD37,000 per day.

We’ve talked about operator needing to pay the full mobilization costs. And you can think about that being around CAD1 million to move the rig up and get it ready to work in Canada. So there’s a lot of requirements we’ll have at our customers if that rig is going to move up. But we also got to be a situation where we oversupply the market. So we’ll think very carefully to make sure that we think it’s sustainable work and that there’s a long horizon of work for that rig. So we won a contract that was one to two years in duration. But we want to have good visibility on work beyond that.

Now what I’d say is that with the LNG project coming on right now in Canada, we are expecting additional rig demand to meet the requirements of that project. And — that’s why we’re targeting kind of something like one or two rigs, we think the market can probably handle. And perhaps we’re like, maybe you can handle a third or a fourth rig, we’ll take it one by one.

Luke Lemoine

Okay. And then just still in Canada, I believe CWC has unutilized rigs, what’s the outlook on those going back to work?

Kevin Neveu

So their fleet is primarily what are classified as telling double rigs. Those are generally shallower rigs that are triples and maybe a little deeper than some of our super singles. They’re commonly used in Central, Southern Alberta and Saskatchewan, it’s an area that Precision hasn’t had a lot of focus in the past. We’ve been really focused on the resource plays, the conventional heavy oil and the Montney. But we’ll certainly bring the CWC team on. We’re anxious to see how they’ve worked. They’ve been very effective in the winter season, they’ve had often all of those rigs running through the winter, all six rigs running quite commonly. So you see us running all six CWC rigs and maybe pulling through a few more of the precision tele-doubles. It would be a very good outcome. And we think that the sales team of CWC can bring some strong market intelligence on that market segment for us.

Luke Lemoine

Okay. If I could sneak one more in real quick. On the US side, I think you said you had 44 rigs operating and some could be reactivated later this year. We’ve seen momentum in various count the last few weeks, especially in the Permian, just on a daily basis. Where do you think kind of your rig count could be maybe six months from now or three to six months in the US.? Just kind of based on conversations you’re having and what you’re seeing?

Kevin Neveu

Yes. I think we’ll be at a fresh budget year from January. And certainly, we’ve already got customer education, there will be more rigs going to work. We’re playing that against a couple of these large acquisitions that have been announced recently between Exxon and Chevron, everyone knows that three plus two equals four, not five. So there’s going to be a slight rig count reduction with those transactions.

But other E&Ps right now that are looking to replace tucks and kind of get back into ensuring they can sustain production. It does feel like rig counts are will up next year. Whether that’s 50 or 75 rigs is a bit hard to project. But if we picked up our share of that and what we see in our pipeline right now, adding the 8 rigs that are operating right now — we’re going to have a rig count back in the low 60s pretty quickly.

Luke Lemoine

Okay. Perfect. Thanks, Kevin.

Kevin Neveu

Great. Thank you.

Operator

Our next question comes from Kurt Hallead with Benchmark. Your line is open.

Kurt Hallead

Hey, good afternoon. Kevin, I know you guys referenced here in your press release and your commentary about a potential doubling of profitability in the international market. Is that — it looks like you’re adding what 1-plus rig, 1.5, 2 rigs on average going into next year. So it doesn’t seem like it’s going to be all volume driven per se. So is there a significant step up in kind of day rate and cash margin you expect from these rigs that you’re going to be bringing online?

Kevin Neveu

So Kurt, there’s a couple of things there. We’re going to average a little bit less than six rigs this year and then next year, we’ll average 8% for the full year. The two rigs we’re adding are higher margin than the other rigs that are running — on average. And we also incurred a bit of cost reactivating these last two rigs that won’t recur next year. So mixing all of that together. We think that an increase in 50% — no, that’s a 50% increase. It’s not a doubling in EBITDA. It’s just a 50% increase going from 6% to 8% with a bit more profitability.

Kurt Hallead

Okay. That’s great. Appreciate that clarity. And then, Kevin, kind of a follow-up for you as you referenced the increased term contract dynamics happening in Canada and 27 rigs now on term contract. Crystal ball in the next 1 to 2 years, given the dynamics around LNG and heavy oil, as you referenced, what do you think that 2017 could become?

Kevin Neveu

I have to promise everything with macro. The macro can affect everywhere all the time. But assuming the macro doesn’t have some massive shift like a pandemic or another war. But we’re dealing with the Canadian market as it sits today with Trans Mountain pipeline coming on and the Coastal GasLink project and then likely follow-on approval of Phase II for LNG Canada. So if we’re running 30 rigs today, that could be as much as mid-30s three or four years down the road, could even be low 30s just by the end of next year. So we could see that recount go from 30% to 32% or 33% next year. And up beyond that could be 35% or it could be 40 rigs kind of down the road.

I don’t think we’re building new rigs. I think we’ve got opportunities to upgrade existing rigs like we did for the 1 rig moving into Canada on January 1. To give you a sense of the capital needs for that, we could probably upgrade one of our older SCR rigs to a full super spec for the rate of $10 million to $15 million, far less expensive than building a new winterized rig. So I don’t think we need a ton of capital to her rig count in Canada go up quite a bit if the LNG projects continue as they look, and heavy oil continues to remain strong.

Kurt Hallead

That’s right. Perfect color. Thank you.

Operator

Our next question comes from Keith Mackey with RBC Capital Markets. Your line is RBC Capital Markets. Your line is open.

Keith Mackey

Hi. Good afternoon. First question is just on the US, Kevin, we know that your rig count over the last year or so had been more private company weighted and you talked about adding 6 public companies this year and increasing your share with two. Just curious, what do you think is the right customer mix for PD in the US in terms of public, private, et cetera? And what do you think needs to happen in order for you to get there?

Kevin Neveu

Yes. Keith, I think that sort of changes with time a little bit. I do think that as US LNG exports start to ramp up in 2024 and 2025. We might be a little less worried about private equity style E&P companies that they’re drilling for gas, if there’s a stronger LNG export market. So if I look back at FY 2020, FY 2021, having that private company exposure and gas exposure was excellent for Precision.

Now, at this point in time today, having more public company exposure, having exposure to the majors, super majors having more oil exposures, what we’re targeting, and we’re delivering on that. It’s not — we can’t make these changes in a week or two. It takes a quarter, two quarters, three quarters but our customer mix at the end of this year will look vastly given at the beginning of the year, and I’m really pleased with the progress our sales team is making on that.

Keith Mackey

Yes. Got it. Appreciate the color. And maybe one for Carey. What are you seeing in terms of maintenance CapEx per rig or maintenance CapEx per day? I guess more specifically on your US fleet? Has there been much inflation from that, 1,500 a day level that we used to always quote? Or where are things trending there?

Carey Ford

Yes. So there has been inflation. We have quoted on prior conference calls that the many capital cost per day was trending closer to 2,000. Now it’s closer to the mid-2000s. But I would point out that that includes drill pipe replacement. And in a lot of cases, we are getting customers to pay for excess wear on drill pipe. And so we’re — it’s showing up at a higher cost in maintenance CapEx, but then we’re recouping it on margins.

Keith Mackey

Got it. Okay. So drill pipe and some other things. What are besides drill pipe? What have been kind of the big drivers in terms of the maintenance capital number increasing?

Carey Ford

So it would be mud pumps, pump maintenance, engines, top drives, all the critical components on the rigs, the repair cost of balance. If you think about R&M, you’ve got consumable components when you do repairs, which have a little bit of inflation in them and then you have labor and labor up across the board and then subscribe it.

Keith Mackey

Yes. Got it. And just one last one. On any activations that you might see in the US, is there — are we talking about any substantial capital requirements to bring any of those rigs back or they all pretty warm still?

Carey Ford

Likely not much maintenance capital. We might have a little bit of operating expense and if there’s upgrades associated with the reactivation there’d be some upgrade capital. But you make the correct point that, a lot of these rigs were working six months or a year ago, they’re not going to be the same type of reactivations that we had to put forward at the end of 2021, beginning of 2022.

Keith Mackey

Okay. Thanks very much.

Operator

Our next question comes from Cole Pereira with Stifel. Your line is open.

Cole Pereira

Afternoon, all. I just want to start on the margin front in the US. So it sounds like some of the costs there were going to reoccur in Q4. Is there anything transitory that is in both Q3 and Q4 or in the event that the rig count in the US doesn’t increase? Is that kind of a reasonable run rate going forward? Just as from your last call, I mean, your rig count in the US is down a little bit, but the margin outlook is quite a bit lower.

Carey Ford

Right. So I think that they will — the cost will trend down a bit more in Q1, regardless of whether we increase our rig count. There — if you think about it, if you have a lower rig count, you’re absorbing a bit more fixed costs, but also if you have a high maintenance cost on a rig, if you have critical funds that need to be replaced, it just shows up more is more prevalent in the average operating cost if you’re running your rigs.

And so we’ve got a few of those where we just had higher R&M post on a particular rig. And it just shows up a little bit a little bit more in the daily operating costs because of it. We do think that some of — there’s a bit of transitory costs in there, and we should see it trending down a bit more

Cole Pereira

Okay. Got it. And then coming back to shareholder returns. You talked about it a little bit, and there’s obviously a few different ways that activity can go next year, but free cash flow should be pretty strong in any reasonable scenario. I mean, from your standpoint, is that you may be thinking about paying down, call it, $150 million of debt or something in that range. And should have a lot left over and then you think about growth CapEx and kind of put the rest in the buyback?

Kevin Neveu

Yes. So we’ll put forward our capital allocation targets to the beginning of next year. I think in general, you’re thinking about it right, correctly, Paul. The — we will continue our debt reduction schedule. We will have capital allocated towards share buybacks. And then I would look at our growth capital the same way that we’ve always looked at it. We’re going to look for opportunities to spend upgrade capital match the contracts where we get that capital paid back and to the extent that there’s opportunity to do that in the market, we’ll pursue it.

Cole Pereira

Got it. Thanks. And you’ve done a few of these bolt-ons now. How do you think about further consolidation just as part of the overall PD strategy?

Kevin Neveu

I think we’ve demonstrated over the past couple of years that we can be opportunistic, we will, but really clearly, it’s not one of our top three strategic priorities. So I don’t think we’re going to pivot and all of a sudden become highly acquisitional focused. We like the stability of the strong balance sheet. But Carey, you get anything to add that?

Carey Ford

Sure. It’s important to note that when we executed the High Arctic acquisition, we were able to remain committed to our debt reduction target for 2021 and 2022. And if you look at what we’re — what we commented on this conference call that we’re going to complete the CWC acquisition and still meet our debt reduction targets for this year. It shows you where our priorities are to get the balance sheet in order and we’re in a favorable place right now where we’ve got some flexibility where we can do some of these tuck-in acquisitions. But debt reduction is still going to be the number one and more folks to the company for the next year or two.

Cole Pereira

Got it. Okay. That’s all for me. Thanks. I’ll turn it back.

Kevin Neveu

Yes. Thank you, Cole.

Operator

Our next question comes from Waqar Syed with ATB Capital Markets. Your line is open.

Waqar Syed

Thank you. Carey, do you expect shortfall revenues in Q4?

Carey Ford

Yes, they will be similar to what we reported in Q3 in the kind of $6 million range US.

Waqar Syed

And when do they fall off? Is Q4 going to be the last quarter for those? Or do you expect them next year as well?

Carey Ford

We might have a little bit at the beginning of next year, but the bulk of this level of IBC revenue will fall off in Q4 or after Q4.

Waqar Syed

Okay. And then as the CWC rigs get on the payroll in next year in the US, how would those impact your daily operating costs and dairy regrets?

Carey Ford

I think it’s a little bit too early to talk about how that’s going to impact our daily operating margins and rates. We’re planning to close the acquisition here in the next couple of weeks, and we’ll be able to talk about that a bit more clearly.

Waqar Syed

Okay. So let’s assume then with our CWC. On your own fleet, when do you expect US margins to bottom?

Carey Ford

Well, there — they could be bottoming right now. We’re not seeing much of a change from Q3 to Q4. It just depends on whether the rig count continues to trend up into Q1.

Waqar Syed

Okay.

Kevin Neveu

Look, I might answer that kind of focused on what you model for rig count next year, but you’re modeling the rig count to move up in that I think that rates of budget margins a bottom.

Waqar Syed

Okay. That’s good to hear. And then, Kevin, you touched upon these big mergers that are happening. And it was mentioned in one case that they would be looking at these for mile type laterals and some other companies have talked about those as well.

What type of rig would be required to drill that? I imagine not every Super Triple rig can do that. There may be even a further subset within Super Triples that would do that. So maybe could you talk about like what exactly — what type of equipment would be required on a rig?

Kevin Neveu

Yeah. I can. So we’ve drilled some 3-mile laterals. We’ve actually drilled a couple of mile laterals they’ve been in shallower plays, not the deeper plays. But any time you extend the length of the well or the vertical depth of the well, either one, you’re increasing the required hope load capacity for the rigs. You need to have the mass has to either be strong enough or been reinforced to be strong enough. We’re increasing the amount of pipe you need to build a rack in the mask so you have to increase the racking capacity of both the racking board and the substructure to support that pipe. And now you’ve got more pipes more weight or everything else to support that weight.

And then because you’re drilling farther and you’re adding more pipe in the ground, you hydraulic horsepower. So we’re typically going from two pumps to three pumps or going from 1,600 to 2,000 horsepower mud pumps. So most of these rigs that — in our fleet, all of these changes for us are kind of bolt-ons. We’re going to bolt on a mass upgrade. We can bolt on a rocking capacity upgrade. You can slide in a third pump, slide in a fourth generator. So the rig doesn’t become obsolete. But these are capital increases.

So they had a third pump on the fourth generator is over $1 million upgrade the mass capacity and have more pipe might be in our case might be less than $0.5 million. And if you want to do all of these things together for one of our rigs is probably the trade working $3 million to $5 million. And the other component is a top drive usually has to have a higher torque capacity. So there’s a bit of work to do on the top drive.

Waqar Syed

All right. Thank you very much. That’s all I have.

Kevin Neveu

Great Thank you, Waqar.

Operator

Our next question comes from Sean Mitchell with Daniel Energy Partners. Your line is open.

Sean Mitchell

Thanks guys for taking my question here. You guys have got the three rigs in Saudi, the fourth and fifth rig in Kuwait. Any thoughts around exploring other international markets? I know Luis Canada and US, but we haven’t really talked about, are there other opportunities international that you guys are looking at? And any color you can add?

Kevin Neveu

Sean, we’ve been clearly focused on maximizing our footprint in Kuwait and Saudi. So for sure, those two countries. We’ve been bidding around the Gulf. We think we can support rigs in Qatar, Bahrain, maybe Abu Dhabi, places like that, from the base of operations we have either in Saudi or Kuwait and our regional offices in Dubai. So we think the entire half regions open to us. We’re not looking really aggressively outside the Gulf. We have had inquiries for Argentina, we’ve got inquiries from Central Africa, not anxious to see us in six to seven different countries around the world. But if we had a one-off chance to put a rig somewhere up to really good day rate, we’d look at that.

Sean Mitchell

Okay. Thank you.

Kevin Neveu

Thanks, Sean.

Operator

And I’m not showing any further questions at this time. I’d like to turn the call back over to Lavonne for any closing remarks.

Lavonne Zdunich

On behalf of the team here at Precision, I’d like to thank people for joining us today, and that concludes our conference call. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect, and have a wonderful day.