Howie
Heres that Barron's oil service article. This is not in the Sat paper edition...just the daily on-line so not nearly as much influence. It is quite positive.
April 26, 1999
The Tank Is Half Full For Oil Service Stocks
By Vito J. Racanelli
Oil service stocks have come roaring back in 1999, but many investors remain
skeptical.
Despite the 33% or so share price rebound so far this year, many investors seem to think
that the recent 60% jump in oil prices won't last: They appear convinced that some of the
more cash-strapped members of the Organization of Petroleum Exporting Countries
(OPEC) will cheat on the latest round of production cuts, causing crude prices to tank
once again.
James Carroll, a portfolio manager at Loomis, Sayles, for example,
has been taking some profits after the recent run-up in the share
prices. Like other wary investors, he's looking for a pullback in the
price of crude and expects that to hurt the stocks in the near term.
He and other skeptics have reason to be cautious. Since drilling rig utilization is still
relatively weak -- about 75% of rigs worldwide, for example, are now in use--and day
rates have plummeted, a significant crude price drop would hit the group hard. Even
after this year's price recovery, stocks of many U.S. oil drilling and oilfield equipment
companies remain off at least a third to a half from their highs, which were set back in
late 1997 before oil prices collapsed.
But in recent weeks a few Wall Street analysts have begun to view the tank as half full
for oil service companies.
These bulls argue that the oil price rise is sustainable and that crude will remain around
the current price of $18 a barrel -- and could even hit $20 a barrel next year. As oil and
gas prices stabilize, the bulls expect exploration and production (E&P) companies to
reverse course and raise exploration budgets for 2000. Eventually, they say, Wall Street
will boost earnings estimates for the group and sentiment should turn more positive.
Andreas Vietor, who heads up oil service research for Hanifen, Imhoff, thinks higher oil
prices are here to stay. Besides the current recovery in global demand, he points out that
non-OPEC production declines aren't being offset by new drilling, keeping supply tight.
(Even Carroll -- the portfolio manager who has been lightening up on oil service stocks
lately -- acknowledges that "the cycle is starting to turn" upward for this group.)
When oil prices hold north of $16 per barrel, most oil companies are profitable, says
Vietor, who expects drilling activity to increase significantly in 2000. By the third or
fourth quarter of this year, exploration companies will start revising their drilling plans
upward, he predicts. That means rig utilization and day rates would start to go up, too.
Tom Marsh, editor of Offshore Data Services, which monitors oil drilling activity, says
that a sustained price of $16-$18 per barrel would likely lead to 90%-95% utilization rates
by the end of 2000, or even before that. But Vietor argues that by then it will be too late
to buy the stocks because the share prices of drillers would already reflect improved
market conditions.
Morgan Stanley Dean Witter analyst John Lovoi, who has an Overweight rating on the
group, maintains that the natural corrective forces following last year's oil price collapse
are already at work: He points out that both oil and gas production in the U.S. are still
falling, and the supply from OPEC continues to dry up as well. Lovoi is convinced the
current rise in oil prices is "for real" because the credibility of Saudi Arabia, OPEC's
swing producer, is riding on the recently adopted production cuts.
Meanwhile, oil and gas demand continues to rise thanks to a buoyant U.S. economy,
reversing the previous cyclical weakness in demand that hurt these stocks.
Vietor, who last week upgraded ratings on
ten oil services companies, says that
shallow- water drillers, land drillers and
integrated service companies should benefit
from an early surge in E&P capital spending
because their contracts tend to be relatively
short -- picking up changes in day rates more
quickly. He upgraded Marine Drilling and
Pride International to Buy From Hold, and
R&B Falcon and Transocean Offshore to
Accumulate from Hold, among other
upgrades.
Lovoi also has been upgrading many oil
service stocks in recent weeks, including
Halliburton, to a Strong Buy from Accumulate; BJ Services, to Outperform from Hold,
and R&B Falcon, to Outperform from Neutral.
Both Lovoi and Vietor acknowledge that on current 1999 earnings estimates, valuations
for the oil service stocks appear stretched. Many sell at double-digit price-to-earnings
multiples (P/Es) on 1999 earnings that currently are expected to fall anywhere from
33%-80%.
But 1999 earnings estimates are a lagging
indicator at this point and incorporate a
crude price that is just too low, Lovoi
maintains. The bulls expect earnings
estimates to start rising by the third or fourth
quarter of this year.
Lovoi estimates the E&P companies could
jack up spending by as much as 15% next
year. That would mean healthy revenue
growth for oil service companies -- and a
sharp improvement in operating profits.
"You're going to see 30%-50% earnings
increases in the group in 2000," Lovoi
predicts.
He thinks that the next upward move in the group's stock prices could come even before
the expected earnings turnaround later this year. It's a small, essentially unloved sector
in which most institutions are still underweighted, he says. That gives it great leverage
on the upside if sentiment shifts -- even before that shows up in better reported
earnings, he adds.
Though oil service shares have moved up nicely, these volatile and beaten-down stocks
still lack the allure of technology and financial superstars. But as crude prices firm and
drilling activity picks up, investors may well rediscover their lost appeal. |
