Schlumberger (OP/A): No one cares about earnings - why? April 26, 2005 - Goldman Sachs
Following strong 1Q2005 EPS of $0.65 that exceeded our estimate of $0.63 + consensus of $0.61, we are raising our 2005 EPS estimate for SLB to $2.83 from $2.76 based on stronger 1Q results + our belief that improved incremental margins are sustainable given (1) mgt focus, (2) improving oilfield pricing trends + (3) the pending ramp-up in high margin deepwater activity. We are maintaining our well above consensus 2006 estimate of $3.45, but see more upside than downside. We are also introducing a 2007 EPS estimate of $3.95. We maintain our O/A rating + fair value estimate of $90 (26x 2006 PE) + remain buyers on dips acknowledging short-term risks of continued macro economic concerns + the pending conclusion of the seasonally strong period for oil service stocks in May.
IF SLB'S FIRST QUARTER WAS SO STRONG, WHY DID THE STOCK GO DOWN?
Despite stronger than expected 1Q2005 EPS + generally bullish outlook commentary from SLB management on its conference call, SLB shares declined 2% yesterday, in line with the OSX and -1% relative to the S&P 500. BJS (IL/A) + ESV (IL/A) also beat consensus EPS and shares fell 4% + 3% respectively. So if earnings don't matter at the moment, what does + when will earnings matter again?
IT'S CLEAR CRUDE PSYCHOLOGY HAS NOT RALLIED BACK WITH CRUDE PRICES although crude prices have rallied off recent lows of $50 (hard to believe we are talking about $50 as a "low" now), it is clear that market psychology has not. Concerns remain over (1) slowing economic growth, and (2) recent OPEC comments that the market is adequately supplied. Despite better inventory numbers of late + the history of energy outperforming in rising interest rate environments, investors remain unconvinced + uncertain as to whether growth is slowing, or something worse than that. The exact data point and timing of a turnaround of macro concerns - i.e. the point when the strong oil service industry micro will reassert itself -is difficult to predict, but the GS house view remains that growth is indeed slowing, not cratering, and we're sticking with it. Our oil price forecast remains $50/ $55 in 2005/ 06, but believe E&P spending would grow 15% in 2005 and 5-10% in 2006 even if oil prices fell to the low $40's. We'd also remind investors that energy stocks have tended to outperform in periods of rising interest rates.
INVESTORS DO NOT APPEAR WILLING TO DISCOUNT STRONG GROWTH IN 2006 YET Oil service stocks appear fairly valued to us on 2005 estimates as they have for a month or two, but 25-35% under-valued on 2006 estimates, which still have more upside than downside. Recent stock performance seems to point to an unwillingness among investors to discount 2nd-year forward earnings estimates - as is normally the case at this point of the year. No matter that long-term rig contracts are proliferating. No matter that oil industry reinvestment rates remain depressed. We do, however, see the logic behind rising risk premium, greater volatility, or truncating time horizons when macro economic concerns increase, oil service industry fundamentals are above mid-cycle (as they are today) and the cycle for the stocks is 2+ years old. Of course, when macro concerns moderate, we'd expect the ensuing rally to be sharp as well.
SOME INVESTORS TELL US ENERGY JUST DOESN'T "FEEL" GOOD RIGHT NOW
Several investors have said to us something along the lines of "energy just doesn't feel good right now - rig newbuilds, large equity offerings, insider sales, building oil inventories, the OSX just won't break through 144-145 on the upside and the stocks are going down on good earnings." Energy generally remains one of the few groups that is up on the year, and, therefore, susceptible to profit taking where few are available generally. Moreover, the seasonally strong period for oil service stocks ends in May, with June a notoriously difficult month for the stocks historically. Traders may be anticipating this as well.
NOTHING WOULD SURPRISE US SHORT-TERM, BUT THE OUTLOOK REMAINS BULLISH, IN OUR VIEW
There is very little that would surprise us in the short-term based on the history of the oil service industry, and acknowledge potential for the group to remain in its recent range, if not retest recent lows. However, we continue to believe fundamentals remain very strong. I will leave the commodity macro viewpoint to my colleague Arjun Murti. For the oil service group, we see continued strong potential for upward estimate revisions. Oil industry reinvestment rates remain very low relative to past peaks of 1980, 1997 + 2001. Capital discipline inside the oil service industry is near all-time highs looking at capex vs any metric - depreciation, assets, or revenue. Oil service capacity utilization is at (or near) full-out. Pricing power is still accelerating with very little real push-back from E&P co.s on rising service costs. Service companies are seeing firming pricing broadly in the Eastern Hemisphere, something we have not seen in our career. Mix will be improving to higher margin deepwater activity in 2H2005. 1Q2005 marks the first quarter this cycle that the oil service group beat estimates on stronger than expected margins - not revenues. Oil service stocks have yet to outperform E&P this cycle as they have in past cycles. Stock repurchase remains prevalent (SLB, BJS, NE, SII), with potential for others to join the party (WFT, NBR).
WE RECOMMEND BUYING DIPS, ACKNOWLEDGING MACRO CONCERNS + UNCERTAIN OF THE NEXT CATALYST
BHI, SII, SLB, RIG and DO remain favorite names and Outperform-rated. Among In-line rated stocks, we have grown more positive on CAM, which has under-performed, but has beatable estimates and potential catalysts via accretive acquisitions.
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. |
