Oilfield Equipment Services 3Q11 Preview
Go Long Service Stocks After EPS Expectations Are Revised
12 October 2011 ¦ 39 pages
citigroupgeo.com
Our Sector Call: Stay on the Sidelines Ahead of Estimate Cuts — Stocks look
cheap, but based on the expectation that analysts may lower their EPS forecasts
against a backdrop of global economic uncertainty, we recommend staying on the
sidelines ahead of 3Q11 EPS reports.
Conclusion #1: First Cuts Could Be a Negative Catalyst — The severe OSX
decline in 3Q11 is ample evidence that investors do not believe current earnings
forecasts for the oil service and drilling companies. Recent weak oil and gas prices
and increased prospects for economic recession weigh heavily on sentiment
despite multiple evidences of strong global demand for oil and gas drilling services.
We believe that stocks could react negatively to an initial wave of downward
revisions even though some portion of those revisions is already discounted. The
overall tenor of this strong earnings season may be negative for stocks.
Conclusion #2: Expect Only Tentative Guidance from Management — Outlook
and guidance will take precedence over current earnings results in 3Q11. However,
management commentary is unlikely to include any forecasts beyond the near-term
horizon due to the current uncertainty in the global economy and in energy prices.
This is not due to a lack of transparency but instead to a lack of information. It is still too
early for oil service companies to model the consequences of a new recession, and
it is too early for the major oil companies, national oil companies, and independent
producers to articulate the potential impact on their capital spending programs.
Conclusion #3: Buy Stocks Once Earnings Revisions Begin — In past cycles,
analysts have been just as slow to reduce estimates in downturns as they have
been slow to raise estimates in upturns. We believe this pattern will repeat this time
around. We expect a gradual reduction in 2012 and 2013 estimates to begin this
earnings season. Once this downward revision process begins, we advise being
quick to take positions in these stocks because fundamentals should remain strong
over the long-term, and past cycles suggest that lagging EPS revisions may
coincide with a rebound in oil service stocks.
Conclusion #4: Focus on Defensive Stocks With Offensive Potential — We
believe companies that take actions to reduce balance sheet risk and fight cost
inflation will be rewarded in these still uncertain times. The stocks of companies that
buy back shares to demonstrate the dissonance between strong long-term
fundamentals and cheap valuations also should benefit. When forward earnings
estimates begin to fall, we recommend first focusing on financially and operationally
defensive stocks. Companies meeting these criteria include HAL, SLB, NOV, DRC,
HP, and LUFK. |
