WEEKDAY TRADER: Beaten-Up Oil-Service Stocks On The Mend
Ensco International Inc.
Dow Jones Newswires -- October 1, 1998
This story was originally published Wednesday.
By Vito J. Racanelli
Barron's Online
NEW YORK (Dow Jones)--It's been a year of steadily intensifying pain for oil-service companies.
Their beleaguered investors have watched share prices drop more than 50% from highs reached back in the gusher days of last October and November.
The culprit, of course, has been the oil-price collapse, as international financial crises have picked off country after emerging-growth country. That decimated global demand growth, and crude fell from around $19-$20 per barrel in the fourth quarter last year to below $12 a barrel at one point earlier this summer.
Down with crude went the Dow Jones industry groups of oil drillers and oil equipment and services, which are off about 57% and 38%, respectively, from one year ago. Out of 95 groups followed, they rank dead last and 93rd.
After the severe mauling these stocks have received, their valuations are among the cheapest around, but the market remains wary.
Sentiment is at a nadir, as many investors expect the group's earnings to fall next year on flat-to-down oil demand. Some might even post losses.
Sometimes, though, things can look so bad for a group of stocks that they start to look good.
Though most of Wall Street is neutral to negative on these stocks, a few analysts have become more bullish in recent weeks. They point to subtle but significant improvements in key areas that indicate the
stocks are bottoming.
And, more importantly, these stocks are likely to perk up far in advance of any recovery in global crude demand, these observers say.
Robinson Humphrey analyst Thomas Escott, for example, last week upgraded his ratings of the two large oil service companies, Halliburton Co. (HAL) and Schlumberger Ltd. (SLB), to Strong Buy from Long-term Buy.
He says that two out of four important indicators that had been negative all of 1998 have turned positive.
First, the Organization of Petroleum Exporting Countries (OPEC) was able to cut back production far more than was generally expected. August data from the International Energy Agency showed that OPEC,
excluding Iraq, cut supplies by over 2 million barrels a day, or 83% of their 2.6 million barrels-a-day target reduction.
That, in turn, has helped push up the second important indicator, crude oil prices, to near $16 per barrel from $12, notes Escott. Already that's been enough for some investors to believe the stocks have hit bottom.
The oil drilling industry group, for example, is up about 20% from late August lows, while oilfield equipment shares are up 5%.
Marina Carlson, who heads up the Strong Opportunity Fund, has noticed that the group is now weathering drastic earnings estimate cuts pretty well. "That indicates they are washed out." She's been nibbling in recent weeks on stocks like Cooper Cameron Corp. (RON) and Nabors Industries Inc. (NBR), among others.
Robinson's Escott concedes that the outlook for the other two key factors - drilling activity and global demand - hasn't turned positive yet.
Yet, if the current price holds - admittedly a big if - it would achieve the roughly $16 per barrel that production companies generally need to make most hydrocarbon fields economically viable.
And with drilling rig dayrates down 50% in some cases, stable oil prices at current levels would go a long way to improving the outlook for drilling activity in the next year or two, Escott says.
Still, global demand is generally expected to grow a paltry 0.5%-1% next year, far below the 2.5%-3.5% growth spurt seen in 1995-1997. In 1998, demand will have grown about 0.4%. But on a longer term basis,
Escott says he's confident that Asian demand will eventually rebound.
By the year 2000, worldwide energy demand will resume an up cycle, he predicts. Once the market recognizes a turnaround in demand, however, it will be too late to buy these stocks, notes Morgan Stanley Dean Witter analyst John Lovoi.
"You want to buy these stocks six months in front of large increases in demand," he says.
Both analysts agree that valuations in the group - where many stocks sell anywhere from six times to 12 times 1999 consensus earnings estimates - are appealing.
Growth, however, varies widely for the drillers from down 50% to up 50%, while the large oil service companies like Baker Hughes Inc. (BHI) and Halliburton are expected to grow earnings about 5% from 1998. But the bulls say that a multiple of 15-20 is appropriate at "normalized" crude prices.
The less-than-certain 1999 outlook means "these aren't all table-pounding stocks, but valuation dictates you overweight the group," adds Lovoi.
Like Escott, Halliburton is among Lovoi's favorites in the oil patch. At Thursday's close of $28 3/4, Halliburton sells at 14 times Zack's consensus estimates of $2.05 a share next year. Moreover, Lovoi predicts that the company's merger with Dresser Industries Inc. (DI) will lead to cost savings of double the $250 million predicted by Halliburton.
Some aren't waiting around for global demand to pick up. Oil service insiders, for example, are buying up shares of their companies at an unprecedented rate. Insiders are traditionally value investors and notoriously bad short-term timers, but last summer and fall they turned out to be prescient indeed, selling heavily just before the stocks began their descent (See Weekday Trader, "Oil Service May Fall Further As Insiders Dump Shares," Nov. 17, 1997.)
About one month ago, there was a sudden turnaround to buying from selling by corporate officials at oil service companies, notes Paul Elliott, a research analyst at CDA Investnet, a firm that tracks such activity.
Companies showing notable insider buying signals include Offshore Logistics Inc. (OLOG), Baker Hughes and Ensco International Inc. (ESV), he adds.
To be sure, serious risks abound for this group. Many energy analysts like Roger Diwan of Petroleum Finance Co. predict that by next spring oil prices will weaken significantly if OPEC doesn't introduce another round of cuts at its upcoming November meeting.
Furthermore, economically pressed producing countries like Venezuela and Mexico are unlikely to tighten the taps any further.
Yet the downside from here appears limited for these stocks. And if the bulls are right, value players with 12-24 month time horizons might find that the dawn for these stocks isn't too far off.
A longterm horizon didn't help Galoob Toys Inc. (TOY) shareholders much, however.
Monday, Santa Claus finally came for Galoob in the form of a buyout offer from rival Hasbro Inc. (HAS) at $12 a share.
That's something Weekday Trader said last year would likely be Galoob's fate (See "Will Santa Ever Come For Galoob?," Nov. 19, 1997).
Still, some shareholders might think Santa brought coal. While the price offered was a 50% premium to the previous close, it's little better than year-ago levels and far less than Galoob's $33 a share high two years ago. |
