From Goldie, this a.m.:
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* It remains premature to throw in the towel on the oil service group, in *
* our opinion, though we acknowledge (1) increased risk to our commodity *
* forecast, and (2) that the 'close your eyes' valuation buy point is *
* likely 10-20% lower. Even if oil prices fall to GS forecasted $23-25 *
* for WTI and $4.50 for natural gas in 2H2003 and 2004 (i.e., well below *
* current futures prices), we believe E&P spending will still rise 7-8%, *
* with OSX upside potential of 25% (OSX 110) until valuations reach *
* historical averages on 2004 estimates. BHI, CAM, SII, and PDE remain *
* Outperform-rated; we maintain our Attractive coverage view. *
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======================== NOTE 8:24 PM July 08, 2003 ========================
* WHY IS IT TOO EARLY TO THROW IN THE TOWEL ON THE OIL SERVICES GROUP? The
case for higher E&P spending, oil service earnings and stock prices on
lower commodity prices has strong economic basis in reinvestment rate
analysis-not to mention precedent (1997). Assuming $28 WTI oil and $5
US gas in 2003 ($25/ $4.50 in 2H2003), cash flow for North America
independents-who drive marginal changes in the rate of E&P spend-would
rise 40-50%, yielding a 10-year low reinvestment rate (spending divided
by cash flow) of 70% and debt reduction below historical norm. Even
assuming a 5-10% decline in cash flow generation in 2004 (our forecast)
independents remain free cash positive even if spending is +7-8% again.
In fact, flat commodity prices would notionally support another +7-8%
spend in 2005.
* WHY HAVE THE RISKS TO OUR COMMODITY PRICE FORECAST INCREASED? The risks
to our commodity forecast have increased because bearish weekly gas
storage injections resulting from demand destruction from high prices
and the unseasonably cool summer weather to date have continued.
However, unpredictable summer weather remains key to discerning a
bullish versus bearish level of gas in storage heading into winter. The
bullish prospect of 2.7 Tcf is fading, but a bearish 3.2 Tcf-which could
push prices below $4 (albeit temporarily)-is still far from given. Oil
inventories outside the US have also risen of late, increasing potential
for higher US imports and lower prices. Lower oil prices would lower
fuel switching arbitrage support for gas prices. If US gas prices fall
below $4 in 2H2003+, our E&P spending forecast and earnings estimates
would likely prove aggressive as North America independents would likely
(1) pause to assess sustainability of US gas demand destruction and
price weakness, and (2) probably have more opportunities to make
acquisitions and buy back stock.
* WHAT IS THE DOWNSIDE RISK FROM CURRENT LEVELS? Near-term weather and gas
injections remain unpredictable, but key. So uncertainty is likely to
linger short-term, suggesting a better entry point probably still lies
ahead. Downside support is likely where valuation risk/ reward
overwhelms commodity risk. At OSX 80-85 (5-10% downside) upside is +30-
38% to OSX 110, which assumes $4.50+/ $23+, +7-8% E&P spend, and average
multiples on 2004 estimates. If bearish gas injections continue and sub
$4 gas emerges, downside is probably closer to 15-20% to OSX 70-75, or
average multiples on 2004 EPS that end up flat with current expectations
for 2003. |
