OIS (IL/A): Strong 1Q expected; Raising estimates and Reiterating IL/A - Goldman Sachs - April 16, 2006
We met with OIS management last week and gained confidence in the company's ability to exceed 1Q2006 EPS consensus of $0.79. We believe OIS's Q1 results will benefit from the extended drilling season in Canada, further increases in land drilling margins and higher rental revenue and margins. We are raising our 1Q2006 estimate to $0.81 from $0.78. We are also raising our full-year 2006/2007 EPS estimates to $3.13/3.60 from $3.06/3.42 due to higher confidence in all business segments with the exception of OCTG distribution. Our fair value increases from $41 to $43 (10x 2007E EV/DACF) = 14% upside and we are maintaining our IL/A rating.
RAISING OUR 2006/2007 EPS ESTIMATES: We are raising our 2006 earnings estimate by $0.07 to $3.13 to reflect higher contribution from Wellsite (+$0.14) and Offshore Products (+$0.02), which was partly offset by lower assumptions for tubular distribution margins (-$0.09). We are also raising our '07 estimate to $3.60 from $3.42 to reflect higher contribution from Wellsite (+$0.13) and Offshore Products (+$0.05), partially offset by Tubulars (-$0.01).
*** #1 - WELLSITE SERVICES - HITTING ON ALL CYLINDERS * ACCOMMODATIONS TO BENEFIT FROM LATE BREAK-UP IN CANADA: We expect the accommodations business to benefit from the extended drilling season in Canada. This year the Canadian spring break-up period began during the final week of March compared to early March last year giving OIS an additional three weeks of peak operations. We believe management was conservative in issuing Q1 guidance due to warmer than normal weather in December which led to weak Q4 results and fears of an early-spring break-up. We estimate an incremental EPS of $0.02 to our original estimate due to the extended Q1 Canadian drilling season.
* EXPANSION OF LAND DRILLING MARGINS SHOULD BE STRONGER THAN INITIALLY EXPECTED: OIS added its 28th land rig during February and continues to benefit from the switch to day-rate contracts versus footage basis in Texas (which was completed in December '05). We are more confident in OIS ability to increase the daily cash margin per rig during 1Q06 to above the company's stated goal of $500. Based on comments from other operators and the fact that 70% of the company's fleet is drilling for oil, we believe margins are more likely to increase similar to levels experienced in Q3 and Q4 of 2005 (+$800 and $900, respectively). We raised our cash margin per rig expansion to $800 from $500. Our new cash margin per rig for the 1Q06 is $5,900/day in 1Q06 vs. $5,600 previously (up from $5,100 in 4Q05). This change increased our Q1 EPS estimate by roughly $0.01.
* RENTAL EQUIPMENT MARGINS BENEFIT FROM IMPROVING MIX: OIS holds a leading position in wellhead isolation equipment and directly benefits from strong growth in pressure pumping demand. We expect pressure pumping to be one of the fastest growing Oil Services segments in 2006 and, therefore, wellhead isolation should increase as a % of total rental sales. OIS' wellhead isolation business carries an EBITDA-margin in the mid 40%s, versus high 20%s for the remaining portion of the rentals business. Rental margin expansion resulting from this mix shift should be faster than we initially expected and therefore we are increasing our 2006E operating margin to 37.5% from 36%.
*** #2 - OFFSHORE PRODUCTS - REVENUE OPPORTUNITY FROM MOORING SYSTEMS LIKELY IN THE UPPER END OF EXPECTATIONS, WHICH SHOULD DRIVE MARGIN EXPANSION: Management previously announced revenue potential of $25 to $50 million to upgrade five 5 mooring systems from Noble Corp, and we now expect revenues to come in the upper end of that range. We increased our revenue forecast to reflect $50 million, from roughly $35 million. We believe these projects will carry gross margins slightly higher than the division average (23%) and provide additional fixed-cost absorption at the company's Houma, Texas facility over the next 9-18 months. Our new assumptions increased our 1Q06 estimate by $0.01.
*** #3 - TUBULAR DISTRIBUTION - POST HURRICANE OVERHANG CONTINUES: We are lowering our tubular distribution margins due to the rising industry inventory levels and OIS's apparent shift toward more carbon grade tubulars. Based on industry publications and discussions with distributors, we believe prices have remained relatively unchanged from 4Q05. High inventory levels appear to have constrained alloy grade pricing while high levels of imports are putting pressure on carbon grade pricing. We view this situation as neutral to OIS in the near-term, but we are concerned with potential margin contraction as inventory levels grow and OCTG prices possibly soften. Our lower margin expectations impacted our 1Q06/2006 EPS estimates by -$0.01 and -$0.09, respectively.
1Q06 READ ACROSS FOR OCTG PLAYERS NOT ENCOURAGING: Our meeting with OIS confirmed some of our concerns from conversations with other companies and some OCTG publications. The bottom line is that high levels of inventory (estimated at 5.5 months of supply and moving higher) appear to be impacting alloy grade prices and rising imports of carbon grade products could hurt OCTG manufactures. Therefore, we are bit more concerned about Lone Star's ability to meet consensus expectations this quarter. We forecast 1Q06 EPS of $1.49 (unchanged) versus consensus of $1.54. The difference seems to be that we are working with a $75 per ton increase in alloy prices, while consensus seems to be using $100 (LSS announced a $100 per ton increase in alloy prices effective January 1). LSS management could try to offset potential weakness this quarter with a share buyback announcement, since uses of cash is one of the key issues for the company.
Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Daniel Henriques, CFA, and Daniel Boyd. |
