OIS (IL/A): Raising estimates and fair value to $45 - Goldman Sachs - May 05, 2006
OIS posted better than expected 1Q results with strength across all divisions except Tubular Services. We are raising our '06/'07 EPS forecast by $0.24/0.22 to $3.37/$3.82. We are also raising our fair value to $45 (10x '07 EV/DACF), which implies a 6% upside potential. While OIS is well positioned to benefit from fast growing segments such as stimulation services (Stinger), deepwater spending and Canadian oil sands, we believe weakness in near-tem OCTG fundamentals are likely to put a cap on OIS stock price performance over the coming months. If GOM activity improves during the second half of the year tubular distribution margins may regain traction. We maintain our IL/A rating for OIS shares.
RECOMMENDATION UPDATE: MAINTAIN IL/A RATING
Our new Fair Value of $45 (10x EV/DACF '07) implies 6% upside. Wellsite Services and Offshore Products are firing on all cylinders and will likely exceed street expectations over the next few quarters, in our view. However, we believe Tubular distribution margins should continue to face pressure over the next quarter as the mix shifts further towards carbon and inventories of large diameter alloy pipe remain high. We believe that near term weakness in OCTG fundamentals are likely to put a cap on OIS stock price performance over the coming months and we reiterate our IL/A rating for the stock.
ACCOMMODATIONS STRONG IN 1Q DUE TO FAVORABLE WEATHER - 2Q SEASONALITY LIKELY TO BE STRONGER
The accommodation business reported strong results in 1Q due to favorable weather conditions in Canada. Revenue was up 45% sequentially and EBITDA margins of 27.9% reached the highest level since 1Q00. Seasonality related to the Canadian break-up will likely hit 2Q harder than the last two years due to the extended drilling season in 1Q. We expect revenue related to seasonal drilling to fall nearly 70% in 2Q and division-wide EBITDA margins of 15%. Revenues related to rental and facilities management in the oil sands region (no seasonality) were up approximately 30% yoy to $25 million. Oil sands related revenue should ramp-up in the second half of '06 as the Beaver River facility (500 beds) and Athabasca lodge (an incremental 1,000 beds) are completed. OIS's exposure to oil sands development is unique for a small cap company and should help provide strong growth as well as increased investor interest.
IMPRESSIVE MARGINS AT DRILLING SERVICES - MARGIN EXPANSION SHOULD SLOW BUT WILL REMAIN SOLID
Drilling services reported better than expected 1Q results as daily cash margins increased $1,300 sequentially, well above guidance of $500 and our estimate of $800. Margins benefited from the switch to day-rate contracts versus footage basis in Texas (which was completed in December '05) as well as a step-up in pricing. We believe increasing costs and a slowdown in price increases will leave sequential margin expansions closer to $500 over the next few quarters.
OFFSHORE PRODUCTS - FIRING ON ALL CYLINDERS
OIS's unique small-cap exposure to deepwater is starting to pay dividends. Backlog was up +100% sequentially to $220 mn and it is expected to increase even more as deepwater spending ramps up and additional mooring system upgrades are announced. We are more confident in the division's prospects and are raising our '06 revenue growth forecast to 24% yoy from 19%. Moreover, with higher margin backlog flowing through the income statement we expect operating margins to reach 17+% by yearend/early '07 (from 12.9% in 1Q06). For example, flex-joints are expected to start hitting revenues in Q3 (e.g. Akpo project). We estimate that flex-joints generate gross margins in the 40% range versus 1Q division-wide gross margins of 25%. Even mooring system upgrades (gross margins ~ 25% range) should provide additional fixed-cost absorption over the next 9-18 months and help push operating margins to record levels.
TUBULAR SERVICES - MIX AND INVENTORY OVERHANG STILL AN ISSUE FOR 2Q; IMPROVEMENTS ONLY IN 2H
Tubular margins fell for the second straight quarter to $167/ton from $202/ton in 4Q05 and $229/ton in 3Q05 primarily due to a larger percentage of carbon sales. Alloy sales declined this quarter due to inventory build in 4Q (especially large diameter) as a result of slowdown in Gulf of Mexico drilling post-hurricane. This had a negative impact on other OCTG participants (LSS included), as a larger percentage of sales are coming from lower margin carbon grades. We believe this trend may reverse in the second half of the year as Gulf of Mexico drilling activity improves and inventory is reduced. However, we think OIS's 2Q mix may still worsen somewhat as Q1 benefited from two large alloy deliveries (CVX's Tahiti and Blind Faith projects).
RAISING ESTIMATES, FAIR VALUE:
We are raising our '06/'07 EPS forecast by $0.24/0.22 to $3.37/$3.82. We also raising our fair value to $45 (10x '07 EV/DACF), which implies a 6% upside potential. The key drivers for our increased estimates were higher revenues and incremental margins in Wellsite Services and Offshore Products.
The $0.24 increase in our 2006 EPS estimate can be broken down as follows:
(1) Accommodations (+$0.12);
(2) Offshore Products (+$0.12);
(3) Drilling Service (+$0.07);
(4) Rental Tools (+$0.05);
(5) Tubular Services (-$.07); and
(6) corporate overhead and other nonoperating items (-$0.05).
Analyst Certification
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, CFA. |
