Smith International (OP/A): Raising Estimates + Fair Value to $73 January 30, 2005
Goldman-Sachs
SII 4Q2004 EPS of $0.57 was in line w/ GS + consensus, but incremental margins did not improve from lackluster 3Q as much as expected. Oilfield revenue was 3% above our estimate, but operating income was 10% lower as high margin deepwater activity remains weak + SII incurred higher SOX + labor expense. Nonetheless, visibility on improving deepwater mix in 2005 is excellent as are higher price realizations in fluids + bits. Mgt raised 1Q2005 EPS guidance + remain buyers of SII stock "well into the $60's". 4Q performance in Fluids + Bits was ahead of HAL + momentum in Distribution continues. We are raising our 2005-06 EPS estimates from $2.45/$2.80 to $2.54/$2.88 despite a $0.025/qtr impact from expensing stock options. We are raising our fair value estimate to $73 from $71 (25x 2006 EPS) and maintain our OP/A rating.
VALUATION UPDATE: On EV/EBITDA, SII Is trading at 11.5x/10.2x our 2005/2006 ests = premium of 3%/5% to the peer group vs. an average historical multiple of 11.7x (4% premium). On PE, SII is trading at 22.6x/19.9x our 2005/2006 estimates, premiums of 3%/9% to its peers vs a 3% premium historically. We believe SII deserves a premium valuation due to its superior ROCE, strategic positioning, balance sheet, mgt and execution track record. We also see more potential upside to our 2005 estimates for SII than other names.
LACKLUSTER 4Q04 RESULTS: SII 4Q04 EPS of $0.57 was in line with our estimate and consensus. While oilfield revenue was 3% higher, operating income margins of 14.4% were below our estimate of 15.6%. Revenue was +1%/ + 8%/ +5%/ +8% in Fluids/ Distribution/ Bits/ Smith Svs vs our expectations. Incremental oilfield margins of 23% sequentially and 16% year-over-year were improved, but still below our 54% estimate and 25-30% normal range due to weak deepwater activity and higher SG&A. Lower tax rate + minority interest offset the 10% operating income shortfall. High margin deepwater revenue was down 50% year-over-year for SII's Fluids business (60-65% of profits). Fluids revenue rose 6% sequentially/ 17% year-over-year vs an estimated -13%/ 0% reported by SII's main competitor, HAL. Bit revenue was +9%/ +26% vs HAL estimated at +0%/ +17%. SII indicates industry data suggests SII gained 1% of mkt share in fluids in 2004.
IMPLICATIONS FOR THE INDUSTRY: (1) SII expects negative EPS impact of $0.11 annually (starting July 1) resulting from the expensing of stock options under FAS 123. CAM, LSS, VTS, and GSF appear to have above industry average EPS impact from expensing stock options. (2) SII indicates about 20% of 2Q/3Q price increase in fluids + bits has been realized and expects full benefit in coming qtrs. (3) SII began to see a pickup in deepwater activity in December (30 deepwater rigs at the end of Dec vs 28.4 in 4Q04), but sees a stronger ramp in 2Q-3Q2005. (4) SII boosted headcount about 10% year-over-year in anticipation of continued improved oilfield activity. (5) 2005 capital spending will increase to $115 mln from $90 mln, but remain in line with depreciation. (6) SII raised EPS guidance for 1Q2005 to $0.60-0.62 vs consensus of $0.59 and indicated that it sees further upside potential to consensus beyond 1Q2005 assuming US gas storage levels do not become a significant overhang on producer psychology.
WHAT TO WATCH FOR (1) SII repurchased $38 mln of stock (about 700,000 shares) in 4Q and has about half of its 5 mln share authorization remaining.
I, Terry Darling, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
