SmartMoney feature on the Oil Patch--mix of positive and negative--
most interesting to me is their conjecture that GLM is a prime takeover target,and suggest Diamond Offshore.
April 2, 1999
Dow Jones Newswires
SMARTMONEY DAILY SCREEN: The Big
'If' For Oil Stocks
By IAN MOUNT
Dow Jones Newswires
Smartmoney.com
NEW YORK (Dow Jones)--Remember the last time OPEC got its act
together? Remember "even" and "odd" days and two-hour lines for gasoline?
Well, the oil barons are at it again and...
OK, so it's not time for a doomsday scenario. The price of a barrel of crude
has moved into the midteens and gasoline has crept over $1 per gallon - not
exactly conditions for a consumer apocalypse. But for offshore oil drillers
such as Global Marine (GLM), Diamond Offshore Drilling (DO), ENSCO
International (ESV) and Marine Drilling Companies (MRL), the apocalypse
has already happened. Share prices for their stocks have plunged as much as
75% from year-ago levels. And while they have rebounded over the past
month or so, in some cases doubling from their lows, they're still far from well
and their recovery is far from guaranteed.
What's it going to take to sustain the rally? "If we have similar conditions to
what we had two years ago - a solid history of two to three years of mirage,"
says Matthew Conlan, an analyst at Prudential Securities. "If we have $18 [a
barrel] oil for two years, we will not have enough rigs to go around." That's a
lot of ifs.
It will take oil prices in the $16 to $20 per barrel range, sustained for more
than a year, for these offshore drillers to register a real recovery, analysts say.
Exploration and production (E&P) companies have to feel comfortable that
the higher commodity prices are sustainable before they begin to invest in
more drilling.
Of course, recently merged E&P companies such as BP Amoco (BPA) still
have to sort out their merged parts, a process that could greatly slow down
their movement on new projects. "We're in a kind of 'snap-back' phase of the
industry cycle, where investor enthusiasm rebounds before fundamentals
rebound and that will only hold if the fundamentals improve," says Dan
Pickering, head of research at Simmons & Co., a brokerage specializing in
the energy sector.
Lewis Kreps, an analyst with Dain Rauscher Wessels, likewise points out that
the sector's fundamentals have not yet changed and says that utilization rates
and earnings will bottom out in the second quarter before rebounding later in
the year.
"In the near term, I think these stocks are going to pull back 10% to 20%,"
Kreps says. "Most oil companies want to see stable oil prices for three
months before they change their [drilling] plans." With unchanged
fundamentals and oil prices uncertain at best, one is left to wonder whether
investors have missed the boat on this sector's recent price rebound. Though
cautionary about the sector's volatility, analysts say that investors still have
time to get in on what they expect to be a recovery over the next few years.
"People have not missed the boat. The boat has barely left the shore," says
Robert Trace, an analyst at Southcoast Capital, a New Orleans investment
bank. But, he cautions, "one has to have an iron stomach to be an investor in
the oil-service group." According to Prudential's Conlan, investors "missed
some of the slam-dunk easy money when these stocks were residing in the
basement. These days, you can get in on the ground floor."
Last week, Conlan upgraded Marine, R&B Falcon (FLC) and Rowan
Companies (RDC) from Accumulate to Hold; raised Transocean Offshore
(RIG) to Strong Buy from Hold; and moved ENSCO to Strong Buy from
Accumulate.
For value investors, this is an attractive sector, with projected price/earnings
ratios for next year as low as 12 for companies such as Atwood Oceanics
(ATW) and R&B Falcon. And, though analysts have consistently cut earnings
estimates over the last several months, Kreps sees some coming in above
expectations, especially those from Atwood and Transocean.
Kreps expects Atwood, which has a First Call analyst earnings consensus of
58 cents a share for the second quarter, to bring in two to three cents more,
and says that Transocean's earnings in the first quarter should be 10% to 15%
above expectations of 71 cents a share. He adds that companies heavily
invested in jack-up fleets (shallow-water rigs) such as ENSCO, Diamond and
R&B Falcon, will face harder times.
Overall, Kreps sees stock prices moving up after their current retrenchment.
"A good time to buy this group is between April 15 and May 15," he says.
"The fundamentals in the group are about to turn." Merger talk in the sector
adds spice to the mix. Some of the smaller players such as Atwood and
Marine have market capitalizations of less than a third of players who are
looking to buy, such as Diamond, Noble Drilling (NE), Global Marine and
ENSCO. Southcoast's Trace says Marine is especially attractive because it is
about to take delivery of two deep-water rigs that can pay off the company's
debt even if it shuts down all of its jack-up rigs.
According to Trace, Marine will likely be bought by Diamond.
Besides its new deep-water rigs, Marine is a "cash-rich" company, making it
doubly attractive as a candidate for consolidation. In addition, Trace points
out that the CEO of Marine, Jan Rask, was the CEO of Arethusa
(Off-Shore), a drilling company that Diamond bought in the spring of 1996,
and therefore already knows James Tisch, Diamond's chairman and CEO. "In
terms of investor potential and take-out, it is the story," Trace says. "I'd be
buying Marine Drilling in droves." (Trace's firm, Southcoast Capital,
co-managed an equity offering for Marine in December 1996, before he was
employed there. The company has done no work with Diamond Offshore.)
Prudential's Conlan also says that Diamond is the most likely buyer of Marine,
pointing out that Diamond is trading at one of the highest multiples in the
sector and Marine at one of the lowest, which means that Diamond can "offer
a premium and still have it be accretive." Still, mergers are by no means a
given. The financial pain that forces companies to merge is not yet present in
the offshore-drilling market, Simmons' Pickering says."Mergers are probably
going to be more strategic than I'm going to take you over because you're
bankrupt," he says.
Whether that financial pain develops or the sector recovers depends on how
long OPEC-member countries can go without cheating on their quotas. As
Conlan points out, even though OPEC managed strong compliance on small
reductions last year, it's been almost 15 years since it's given the world reason
to bet on its cuts.
For more information and analysis of companies and mutual funds, visit
SmartMoney.com at smartmoney.com
Briefing Book for: ATW | DO | ESV | FLC | GLM | MRL | RDC | RIG |
