Will Well Run Dry for Oil Eq/Serv Stocks?
Like a gusher, the oil equipment and service sector has shot higher over the first 5-months of the year. Of the 11 stocks followed by Briefing.com, 10 are posting year-to-date gains, with an average return of 36.3%. Even more impressive are the distances the stocks have climbed off of their respective 52-wk lows. These range from 24.8% on the low-end to 154.7% on the high-end [Smith International (SII)], with the average being 79.5%. Rising crude prices, production cutbacks out of OPEC, an improved economic outlook in Asia and stronger than expected domestic economic growth are among the forces driving investors back into this beleaguered group. Can the sector sustain its advance, or will the well run dry on the rally? For the following reasons Briefing.com contends that the rebound has about run its course.
No Faith in OPEC
When crude prices fell to $11 bbl in 1998, they reached their lowest (inflation-adjusted) level since the depression. Consequently, when OPEC reversed its ill-timed production increase of 1997, the market let out a cheer. Especially since the production cuts coincided with evidence that the Asian/Pacific region was turning the corner on its long, painful economic slowdown. But as is often the case when OPEC promises production cuts, words speak louder than deeds. In other words, member nations are cheating. And given the volatile political/economic climate of many OPEC and non-OPEC oil producing countries, additional cheating is not only probable but likely. Given that the recovery in crude prices has been more supply than demand driven, news that OPEC not living up to its quotas won't play well in the oil patch.
Asia's Phantom Growth
Though Asia accounts for only about one-quarter of the world's oil consumption, it is the geographic region that is projected to deliver the greatest demand growth over the next several years (as it had over the past several). That explains why crude prices plunged as the Asian financial crises worsened, and why they have recovered on early signs of economic progress. But it is a mistake to confuse progress with robust growth. In fact, most economists continue to expect Japan to post negative GDP growth in CY99 and only negligible growth in CY00. The outlook for the rest of the region isn't much brighter. And should the recent rise in US rates manage to slow our economy, resulting in fewer imports from the region, the fragile Asian recovery could quickly breakdown.
Consolidation Among Producers
Skepticism over OPEC's ability to deliver on production cuts and uncertainties over the sustainability of the Asian economic recovery just two reasons why oil producers are unlikely to increase exploration budgets in FY99, or early FY00. Given recent consolidation within the industry, management is apt to (temporarily) turn its focus from production growth to improving operating efficiencies. Not only that, but reduced number of producers means that remaining companies will have increased pricing leverage over drillers and service companies.
Crude Prices
In order for the major producers to bolster exploration budgets in FY00, crude prices need to remain above $16, maybe even $17, for a sustained period. The recent drop in supply helped oil prices rise to this area, but unless demand picks up materially, Briefing.com expects crude prices to fall back to the $15-$14 range. In this price range, oil producers won't be inclined to adjust their budgets favorably.
Valuations
The modest improvements in industry conditions have more than been accounted for by the sector. As the table below illustrates, the group's earnings picture over the next couple of quarters, and for all of FY99 remains bleak. While most of the component issues are projected to post moderate earnings gains in FY00, traders should note that in each case the FY00 numbers fall well shy of FY98 results. In other words, it will be at least two years before the group gets back to the earnings power it experienced in FY98, and that's if the street's macro outlook is accurate. That said, Briefing.com finds it hard to justify the lofty multiples sported by the group's leaders, not to mention the fact that a handful of the stocks are within striking distance of their 52-wk highs. We understand the anticipatory nature of the market, but in the case of the oil services and equipment sector the recent gains are a case of too much too soon.
Stock/Price YTD Gain/(Loss) June Qtr Est v. Year-Ago Sep Qtr Est v. Year-Ago FY99 Est v. Year-Ago
Baker Hughes (BHI) 32 3/4 85.8% $0.09 v. $0.46 (-81.3%) $0.13 v. $0.20 (-35.6%) $0.52 v. $1.05 (-50%)
R&B Falcon (FLC) 9 9/16 26.4% -$0.06 v $0.36 (-116.7%) -$0.03 v $0.21 (-112.1%) $0.00 v $1.04
Global Marine (GLM) 14 5/8 62.5% $0.15 v $0.42 (-65.5%) $0.11 v $0.27 (-60.8%) $0.58 v $1.27 (-54.3%)
Halliburton (HAL) 42 7/8 44.7% $0.19 v $0.51 (-62.5%) $0.26 v $0.44 (-40.5%) $0.97 v $1.67 (-41.9%)
McDermott (MDR) 25 7/8 4.8% $0.40 v $0.55 (-27.3%) $0.38 v $0.85 (-55.3%) $1.70 v $2.61 (-34.9%)*
Noble Drilling (NE) 18 9/16 43.5% $0.11 v $0.38 (-70.9%) $0.15 v $0.25 (-41.7%) $0.62 v $1.24 (-49.8%)
Nabors (NBR) 23 70.4% $0.08 v $0.33 $0.11 v $0.27 (-60.5%) $0.47 v $1.16 (-59.3%)
Schlumberger (SLB) 60 7/16 30.3% $0.27 v $0.69 (-60.6%) $0.30 v $0.63 (-52.8%) $1.31 v $2.49 (-47.6%)
Smith Intl (SII) 43 15/16 74.4% $0.12 v $0.62 (-80.8%) $0.18 v $0.50 (-64.1%) $0.68 v $2.07 (-67.2%)
Tidewater (TDW) 26 3/16 12.9% $0.32 v $1.05 (-70.0%) $0.29 v $0.98 (-70.8%) $1.12 v. $3.19 (-65.1%)*
Transocean (RIG) 24 1/2 (8.6%) $0.58 v $0.69 (-15.7%) $0.44 v $0.84 (-47.1%) $2.31 v $2.95 (-21.8%)
Consensus estimates in table provided by Zack's.
* represent FY00 estimates
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