Sergio thanks for the heads up on the oil article. Even though ESV wasn't mentioned, they fit the criteria perfectly. To me it reaffirms our long term buy on ESV. It was also nice to see them mention KEG as a buy. Here is the question answer segment.,
Briefing: With the long lead-time for oil drilling projects, does this near-term decline in oil prices pose a serious threat to the earnings outlook for oil drilling companies in 1998? What is your outlook for crude prices for the rest of the year?
Ken Sill: The current slide in energy prices won't pose a serious threat to the deep-water drillers, yet it could have a negative impact in the second half of the year on the shallow-water drillers. As for oil prices, we believe they are a lot closer, at current levels, to their lows than their highs for 1998, and look for them to move higher going forward.
Oscar Hern ndez: Industry sources have suggested 1998 E&P spending will increase by slightly more than 10% over 1997. However, since the fall, oil prices have retreated about 30%. Over this same period, we have identified about 1% in meaningful budget cuts identifying domestic land and some Latin American regions. Meanwhile, the oil service industry market capitalization has decreased by one-fourth from $215 billion in November to about $160 billion today, most of this decline preceding any meaningful estimate cuts by industry analysts. We have set our earnings estimates at reasonable levels given the current commodity price environment, but we are emphasizing selectivity in our investment recommendations.
Although the near-term direction of oil prices may be difficult to predict, we believe self-correcting mechanisms exist in the industry which will lead prices to return to more reasonable levels of between $17 and $19 per barrel in the second half of 1998. We would point out that over the last 15 years, oil prices have remained above $17 per barrel 85% of the time due to these self-correcting mechanisms.
Briefing: Will recent posturing from major oil companies to have dayrate prices reduced in the wake of declining crude oil prices prove successful?
Ken Sill: Considering that Amoco was one of the more vocal companies, and they turned around and signed a contract calling for dayrates of $205,000, it is doubtful that posturing will have any success. Demand remains high for rigs, and the oil companies will have to pay accordingly. There is more exposure to dayrate softness for shallow drilling rigs, which have shorter contract terms and are more sensitive to commodity price fluctuations. We are actually seeing some rate declines for land rigs.
Oscar Hern ndez: We have not seen a widespread reduction in daily rental rates for the drillers, although isolated incidents have been verified domestically on land. What we have seen is a deceleration/stabilization in rates. Companies that are gas-weighted are better positioned against rate reductions given that this commodity has been stable despite above normal inventories. In addition, we believe gas should perform stronger in the second half of this year in the face of a more normal winter. Longer-term, however, given a recovery in oil price, we certainly believe posturing for rate reductions will prove unsuccessful due to limited capacity in the industry.
Briefing: Driven lower amid concerns of over-supply, weakening demand for oil from Asia, and the threat that oil companies will reduce spending on drilling projects, stock prices for many of the oil drillers are well off of their 52-week highs. Would you agree that they have been oversold?
Ken Sill: It is difficult to say if they've been oversold since they trade up and down with the commodity which goes to show that oil prices do matter. If oil comes back to a reasonable range ($17-$19), then they are definitely oversold, but if prices remain in the $14-$16 range, estimates will come down more than expected and the stocks might not be oversold. From a valuation standpoint, these stocks are cheap, and look good relative to an over-valued market especially given that downward earnings revisions appear to have already been factored into share prices.
Oscar Hern ndez: I would go back to my previous response. Despite seeing about a 1% meaningful reduction in budget cuts, the oil services market capitalization has decreased by more than 25%. Even post our revised estimates, many of these stocks are trading not far from historical peak multiples when we believe we are many years away from peak. Given that we believe oil prices will recover, we certainly believe the group has been oversold.
Briefing: Which stocks are you recommending and/or avoiding?
Ken Sill: We like the deep-water drillers and have BUY ratings on Diamond Offshore (DO), Transocean (RIG), R&B Falcon (FLC), and Atwood Oceanics (ATW).
Oscar Hern ndez: We are recommending companies with one of three characteristics: (1) deepwater exposure, (2) international exposure, or (3) gas-weighting. Our respective top picks are Diamond Offshore (DO - $43; 1-Buy), IRI International (IIR - $12; 1-Buy), and UTI Energy (UTI - $13; 1-Buy). Diamond Offshore is a premier deepwater driller with a significant share of the deepwater Gulf of Mexico market. IRI International is leading global supplier of oilfield equipment. IRI recently announced its merger with Hitec, a world leader in automated offshore oilfield equipment. UTI Energy is the fourth-largest domestic land driller, currently trading at a substantial discount to its peers.
Other quality companies fitting these characteristics are R&B Falcon (FLC - $26; 1-Buy), Global Marine (GLM - $23; 1-Buy), and Key Energy (KEG - $16; 1-Buy). We would avoid companies which do not fit this criteria.
Cary |
