For those interested in the oil service sector:
By Susan Pulliam
Staff Reporter of The Wall Street Journal
Oil-service stocks got whacked Tuesday, the group's second big hit in
less than a week, and some investors are beginning to question whether
the group's 18-month bull run is fading.
Traders pointed to a laundry list of explanations for the broad
decline in the group, which dragged down by 5% the Philadelphia Stock
Exchange's oil-service sector index. The list includes an easing of
Mideast tensions and softening demand in Southeast Asia.
Among the hardest hit were Ensco International Inc., Rowan Cos.,
Noble Drilling and Reading & Bates.
But it isn't just the Mideast situation that threatens to upset the
apple cart for oil-service stocks. This year, the group has become
heavily owned by mutual funds and other institutional investors, not to
mention hedge funds.
Lately, hordes of investors have become "oil bugs," making the group
the year's fourth best-performing group in Standard & Poor's 500-stock
index. The group came roaring back after the Bloody Monday stock-market
plunge on Oct. 27, with the oil-service index hitting a high of 141.25
on Nov. 5. That was due partly to fears of a U.S.-Iraq showdown, which
could pinch Mideastern oil supplies and spark more demand for supplies
from U.S. producers.
But traders warn that when the group's upward momentum dies, its
tumble could be dramatic. "These companies are way over-owned," says
Seth Tobias, a hedgefund manager who has held big positions in
oil-service stocks this year. "The group's been a big engine for the
overall market," he says, adding that if the group slips, "it could be
the next leg down in the market."
Tuesday's decline was foreshadowed by a roughly 7% slide in
oil-service stocks last Thursday, when rumors circulated that Chevron
was about to cut back its drilling activity in the Gulf of Mexico.
Investors also fretted last week, as they did again Tuesday, that
slumping economies in Southeast Asia could also hurt oil consumption.
Friday, Wall Street charged forward to defend the oil-service group,
with analysts from no fewer than eight securities firms reiterating
"buy" recommendations. The Street's response helped spark a rally
Friday, but the bounce was short-lived. And that has investors really
worried.
Says one longtime believer in the oil-services story who concedes he
is now losing faith: "This is the first really big crack in the group.
Before, the money would just come flowing back in. What that may mean is
that you just can't rely on the fundamental story to bail you out,
anymore," he says.
"What this signals," says Mr. Tobias, another believer that the group
may have turned down, "is that investors are so nervous about the broad
market that they are willing to sell any group, including this one, that
has a hiccup."
Indeed, the oil-service group took a dive in March mainly because of
a seasonal slowdown in the business. But the group bounced back quickly
because so many investors believe the fundamental story is still strong.
Oil-service companies have benefited as oil prices have risen during
the past several years. That's because when oil prices were plunging in
the 1980s, few rigs were built, leaving the industry with a shortage
when rig utilization began climbing several years ago. One sign of the
shortage has been soaring "day rates" on drilling rigs, which have
climbed as much as 50% recently.
But some investors say day rates aren't increasing at the same rate
these days, which could signal, at the very least, that the group has
lost its momentum. At worst, some investors say, it could be a sign the
group has peaked.
Momentum in crude oil prices, which surged from $18 a barrel in early
1996 to the $25 level by the end of that year, have hovered in the
$18-$23 range this year, turning down recently to about $20. Tuesday,
another ominous sign emerged when U.S. crude oil stocks were reported up
almost four million barrels, instead of being down 700,000 barrels, as
expected.
Investors may not take another reminder that oil stocks are cyclical
lightly. Indeed, some oil-service stocks, such as Cooper Cameron are
trading at multiples as high as 12 to 14 times cash flow, or earnings
before interest taxes and depreciation. The group overall trades at
around 8.5 times EBITDA. That's not nearly as high as the historically
high multiple of 9.5 to 10 times cash flow that the group traded at in
the early 1980s, but it is well above the historical average of five
times to seven times cash flow.
The difference now, investors say, is that the group is so widely
owned, which as any student of "Marlboro Friday" will tell you, can lead
to an ugly sell-off as institutions turn tail.
Tuesday, Wall Street was eerily quiet on the group, after rushing
forward en masse to sing the group's praises last week. The message from
nearly all the firms was the same: The fundamental story behind the
group's rise is intact.
"None of the offshore drillers we spoke with saw any signs of
weakness," said Jefferies & Co. analyst Roderick McKenzie on Friday.
Goldman analyst, John Reynolds, weighed in with additional positive
comments the same day. "We believe that as a group, the stocks will
again outperform in 1998."
Pointing out that many of these stocks are up between 50% and 100%
for the year, Morgan Stanley analyst John Lovoi told clients that he
could not "help but believe that a significant portion of the last two
days' selling related to portfolio-manager apprehension."
Prior to the sell-off that began Thursday, according to Mr. Lovoi's
report, EVI Inc. was up 136% for the year, the biggest rise among the
group. Second was Coflexip Stena Offshore, up 121% for the year.
Petroleum Geo Services has climbed 83% this year, while Halliburton was
up 78% before the recent sell-off. |
