Playing the Crude Oil/Gas commodity price recovery correctly...(IMHO).
I think we all agree that in general; ''It is, the price of Oil - Stupid'' that drives the Oilpatch. However, the initial recovery and the far forward looking expectations are unquestionably based on the recovery of Crude & Nat Gas prices; but - this mid-recovery leg is not. It will be based on the fundamentals of cap ex spending; which determines rig utilization, dayrates, new equipment & service orders and thus; cash flow and earnings. Below is just one Brokerage House's thoughts on the Oilpatch - but SSB's is virtually no different that the rest of the Street.
Bottomline; this Q2 earnings report and the fundamentals will be worse, not better than Q1. Most do however agree, that ''this'' will be the trough, or the bottom in earnings and fundamentals, but they said the same thing in Q1.... the recovery has been slower than virtually everyone had predicted. Earnings estimates are ''STILL" being cut for the remainder of 1999 - now everyone is talking about a 2nd half 2000 timeframe untill actual fundamentals improve.
The $64 question is; how will the market react to the coming Q2 earnings release season beginning later this month and how will the street value the Oilpatch through the remainder of 1999 given the poor fundamental outlook - but the positive forward looking longterm expectations ?
IMHO; one major factor is the rebound of the overall market. With the tech & Internet sectors recovering and the total market breaking out to new highs with a DOW 12,000 firmly in sight off of a Fed .25 bps hike and most importantly, maintaining a ''neutral'' bias - the pull of funds into these nearterm ''hot'' sectors will hurt the Oilpatch. At least part of our recent move was from the rotation into cyclicals, I see little sector rotation into the Oilpatch given the fundamentals nearterm of the overall market compared to the Oilpatch and we may even see a drain of funds into these hot sectors.
The Street will not infuse large amounts of cash into the Oilpatch untill the fundamentals have taken a firm turn up. Those numbers are clearly defined by the Street. The sustainability of $18-20 Crude is linked to sub 320 M boe of US storage and of course continuing positive expectations of Asian demand recovery. Also, an Industry standard is 150 GOM Rigs at work - this is necessary for ''rising'' dayrates.
Big Oil & Independant Cap Ex spending is NOT going to be stepped up industry-wide in 1999 an perhaps not untill 2H 2000. The ''play'' actually is to own these E&P companies who on an individual basis have the liquidity and the ability to step up their own cap ex spending and to take advantage of rising commodity prices here.
I see nothing in the next 3, even maybe the next 5 months to break us out of a 15% up and down trading range. Regardless of crude prices sustaining here, or even breaking $20; cap ex spending and the resulting needed change in fundamentals will not occur untill after Q1 2000. Sure, we may get a breakout off of a Crude Oil breakout over $20, but this will be an opportunity to sell into strength imho.
The E&P sector has such superior fundamentals and growth in earnings, cash flow and all valuation metrics, when compared to OSX stocks - that there is literally no logical comparison imho...
HSE is a small cap E&P company for example. Small cap E&P's usually trade at 4-9 times cash flow per share (cfps) and 5 x cfps is a historically conservative valuation. HSE has 1999 projected cfps of $4.28 x 5 = $21.40 per share. HSE is selling at $15 3/16ths; giving a potential 50% upside from here, just on the realization of peer group, historic valuations. HSE is also coming off of a large Q1 upside suprise, with just raised Q2 and 1999 estimates; HSE will also grow cfps at nearly 50% into 2000 to $6.22 cfps x 5 = $31 target price, for 2000 - a near 2 1/2 bagger.... For companies like this; or CRK - which is valued at less than 1/2 of peers on a cfps basis, of EBITDA, or NAV valuation metrics; the upside valuation potential of these small & mid cap E&P's who have fundamental momenteum and an unrealized historic valuation, greatly exceed even the most optimistic OSX upside for the next 6 mos. imho. Personally; I am moving to a near 80:20 E&P vs. OSX portfolio weighting. I will actually even move to just 3-4 individual OSX stocks and am also leveraging upside to just 5-6 E&P's here that have the most unrealized valuations.
I view this as a risk vs. reward anomaly; with the potential to achieve 3-4 times the returns over the OSX index in the next 6 months - which may be a fundamental ''deadzone'' for the OSX untill Cap Ex spending, rig utilization, dayrates, new equip & service orders and backlogs substantially change. The keyword is ''substantially'' change. While we all can site numerous news clips of increasing cap ex spending, new orders etc. - it is NOT changing on a sector wide basis as what will be shortly reflected in Q2 earnings reports by the OSX. Do NOT be misled by what can be interpreted as a substantial upswing - look at rig counts, more importantly dayrates and the backlog's of the service and mfg. companies - we are no where near the specific fundamental triggers to support ANY type of a substantial breakout.
Here is a cold slap in the face; ie: the OSX from SSB:
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Salomon Smith Barney: comments on coming Q2 earnings season:
--SUMMARY:----Offshore Drilling
* Offshore drilling companies are expected to report year/year EPS declines averaging 86%, and sequential declines of 33%. * Rig utilization has slumped to 74% from 78% in the first quarter, continuing to put pressure on day rates.
--SUMMARY:----Oilfield Equipment & Services
Second quarter oil service results will be weaker than previously expected * An extended spring breakup period in Canada, erosion of international activity and increasing price pressures combined to push profits lower across the entire group * June quarter results appear to be the cycle nadir (as expected), but at lower levels then previously projected * We are cutting June quarter estimates for most of our oil service group, and in most cases trimming our 1999 full year estimates ....
--OPINION:------------------------------------------------------------------
Although the tide is clearly turning for oilfield demand, the change is
coming more slowly than many had anticipated; it appears that worldwide rig count in the second quarter will be down approximately 35% from last year and over 20% sequentially. North American rig activity is on the upswing, and leading indicators suggest the worst is past. However, an extended Canadian spring breakup and further international activity declines have more than offset this modest late quarter improvement. Of greater concern are reports of heightened price competition in select international markets, which continue to maintain downward pressure on service margins.
We remain convinced that the June quarter marks the low water mark for the year's earnings, but at a rate considerably less than anticipated; in our opinion, this shortfall may not be made up in the second half of the year (in most cases).
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... no one questions the extremely bullish 2-3 year out look for the Oilpatch, especially given the positive expectations of Asian demand recovery coupled with OPEC doing a fine job compliance-wise. But, for trading - there are some incredible opportunities for those willing to not get blinded by ''mere'' potential, versus those companies with real fundamental momenteum and for those individual investors who are willing to turn over some small cap rocks... the upside rewards are compelling.
For now; it's an E&P play.
Good Luck. |
