Nothing really new here for veterans of this thread, however it's nice to see it all consolidated into 1 discussion:
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Updated: 31-Jul-98
StreetBeat is designed to provide you with additional insights on the market from recognized financial experts on (and off) Wall
Street. Please note that the views and opinions expressed by the panelists below are not necessarily those of Briefing.com.
This week's topic: Oil Service Cos
Panelists
Joe Agular, Partner and Senior Energy Analyst at Johnson Rice.
Angeline Sedita, Oil Service Analyst at A.G. Edwards & Sons, Inc.
Q&A
Briefing: Is the oil service business in a sustained cyclical downturn?
Joe Agular: In the last quarter of 1997, four events conspired to move oil prices lower: OPECs raising its quota, Iraq's return to the
market, Asia's economic upheaval, and an unusually warm winter. In the last 7-8 months the oil companies have been losing about
$5-6 per barrel in revenues. The natural consequence of sustained low oil prices is that oil companies cut capital spending and
cancel projects as the economics become less attractive. There is always a lag in this process but it will eventually cause supply to
diminish and prices to rise.
In the last 15 years oil prices have been less than $18 per barrel for four consecutive quarters only three times; in 1986, 1988 and in
the second half 1993/first half 1994. Absent any unforeseen economic disasters in Europe or the US, we don't think that this will be a
sustained cyclical downturn. If OPEC complies to some degree with current production quotas, we think that oil prices will begin to
push higher by early 1999. In spite of that, we think that Q3 and Q4 of this year and Q1 and Q2 of next year will be sloppy for the
industry because of the lag effect as the industry catches up with oil price changes. Assuming that prices return to over $18 per
barrel in 1999, we think that the oil service business will bounce back.
1999 estimates have been coming down rapidly and the numbers are beginning to look reasonable based on current events. In the
next 4-6 weeks we should see this adjustment process shake out and these stocks will look more like value plays as they should be
trading at multiples of reduced earnings estimates. Most of the bad news has already been factored in and we could see some buying
begin as investors attempt to call the bottom. Unlike 5-10 years ago, most of the oil service companies will be able to weather this
downturn. They are not nearly as burdened with debt as they were in the last cycle. Managements are more profit-oriented and
quicker to cut costs when necessary. We think that the bottom is maybe a couple of months away and that this group should be on
investor's watch list. In the long-term, most of the oil service companies have strong franchises and will be a good contrarian play.
Angeline Sedita : Industry cycles can range anywhere from 3-10 years. Bearing that in mind, this short-term weakness in commodity
prices has not instigated a sustained cyclical downturn. While there have been some spending cuts, and a few larger companies
have begun laying off employees, we feel these are prudent decisions as management is reacting quickly to cut costs now before oil
prices become ingrained at lower levels. It is worth noting, however, that the majority of CEOs in this business don't expect oil prices
to stay at these lower levels over the long-term horizon. Their optimism is rooted in the fact that the world's excess production
capacity has shrunk from 37% in the early 1980s to 2% today. Also, that the worldwide demand for hydrocarbons continues to be at
stronger rates than historical levels. Ultimately, the oil market is in a equilibrium state and will eventually correct itself.
Investors may be inclined to think that since stock prices have sold off so much, the industry is in a cyclical downturn. Stocks, in our
opinion, have fiercely overreacted to the commodity weakness, and have been driven as low as they have due more to psychological
than fundamental reasons. Strikingly, many of the oil service stocks are trading near their 1996 price levels despite the fact that
they're earning two to three times more than they were then. Once the market perceives that oil prices have convincingly turned the
corner, we believe the market will quickly discount the better expectations into thje stock prices for these companies.
Briefing: There has been disproportionate cuts in spending on land and shallow-water projects versus
deep-water projects. Which companies have been most impacted by this? Do you expect that these stocks
will trail in a recovery?
Joe Agular: The three hardest hit segments in the oil service group are the land drillers (US and Canada), the commodity tube
companies, and the work-over well servicing companies. The hardest hit drillers include Grey Wolf (GW), UTI Energy (UTI),
Patterson Drillers (PTEN), Bayard Drilling (BDI), Parker Drilling (PKD), and Nabors Industries (NBR). The tube companies
include NS Group (NS), Maverick Tube (MAVK), and Lone Star (LSS). The work-over well servicing companies include Pool
Energy Services (PESC), Dawson Production(DPS) and Key Energy (KEG).
These companies tend to have high operating leverage to long-term cyclical upswings If oil prices begin to rise and and if investors
perceive that the recovery is sustained, then the oil service stocks will do well because investors appreciate the value of their
operating leverage and we will probably see these stocks jump pretty quickly.
Angeline Sedita: If oil prices are weak, marginal projects are the first place where spending is reduced, and that's what is happening
in the land- and shallow-water drilling areas. Land drillers, in particular, have born the brunt of these cutbacks as many are
significantly exposed to the commodity weakness. Companies that have been adversely impacted are UTI Energy (UTI), Bayard
Drilling (BDI), Key Energy (KEG), Nabors Industries (NBR), Patterson Drillers (PTEN), Grey Wolf (GW), and Parker Drilling
(PKD).
Oil service stocks tend to be leading indicators. When stock prices begin moving up, it may take a couple of quarters to see the
operational improvement in the companies themselves, yet we suspect that the aforementioned land drillers will participate actively in
any ensuing recovery.
Briefing: Will further reductions from OPEC be the catalyst for a sustained rise in oil prices or will an
abnormally cold winter and an economic recovery in Asia also be necessary?
Joe Agular: All three would be terrific for the oil industry. There is roughly six months of oversupply in the oil market and as that is
worked off and the OPEC countries continue to feel the pinch of low oil prices, the market will return to a better fundamental
backdrop, barring any European or US economic crisis of course.
Angeline Sedita: All of the above will be contributing factors to a rebound in oil prices. OPEC will certainly have to abide by its cuts,
and evidence of its compliance will be reflected in inventory levels. Further, it is important that we see continued economic strength in
the United States and Europe. As for the weather, it isn't necessary that we have an abnormally cold winter. A normal winter would be
sufficient enough to help trim supplies to a level that would help drive prices higher.
Briefing: Which stocks are you recommending and/or avoiding?
Joe Agular: We have our highest rating, a BUY, on J. Ray McDermott (JRM) and McDermott International (MDR). They both
have exceptionally strong balance sheets and are currently priced at rock bottom levels. JRM is trading at $28.75. They have $18.75
per share in gross cash and $12.62 in net cash (after debt) on the balance sheet, which means that you are essentially buying them
for $16 per share. We have estimates of $2.40 for FY99 and $2.65 for FY2000. Take out excess cash and JRM is selling for about 7x
earnings. JRM is exclusively an off shore company and has an excellent management team which is shareholder friendly. MDR owns
60% of JRM.
Angeline Sedita: Our favorite is Transocean Offshore (RIG) due to its highly visible earnings and significant exposure to the deep
water segment where prices have been sustained because of the long-term horizon of the drilling projects and resulting long-term rig
contracts. Transocean has 99% of its rig fleet time committed in 1998, and 75% in 1999. When sentiment improves, oil service stocks
in general should do well as we suspect a "rising tide will raise all boats." |
