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Oil Service Stocks Soar, and Analysts See Further Upside
By Mavis Scanlon
Staff Reporter
6/18/99 7:23 PM ET
Oil service shares are closing in on or hitting 52-week highs. Now what?
It's been almost three months since an OPEC-led agreement to cut production boosted oil prices and rejuvenated sagging oil service and energy shares.
The Little Index That Could
The comeback has been admirable, but
how much room is there to run?
The Philadelphia Stock Exchange oil service index has soared 70% since early March and is flirting with an 11-month high. It closed Friday at 80.27, down fractionally. Certain sub-sectors in the industry, such as land drillers and mid-cap service companies, have nearly doubled year-to-date, while some individual issues, such as land driller Nabors Industries (NBR:NYSE), have more than doubled since their March lows.
But now the group is no longer dirt cheap, so the question is: Do the stocks have more room to run?
Yes, says Dan Pickering, head of research at Simmons & Co., a Houston-based energy investment bank. Pickering believes that relatively strong demand growth for oil and gas will continue, on the order of 1% to 2% per year, and producers will have the cash flow -- and the confidence in oil prices -- to increase capital spending.
The group is "still underpriced," agrees Sam Israel, a partner in Bayou Securities, a hedge fund in Stamford, Conn., that trades the group. There isn't enough drilling taking place now to replace production, especially domestically, he says.
Indeed, the latest non-OPEC supply estimates from the International Energy Agency have been revised downward. Simmons estimates a non-OPEC production decline of 1 million barrels per day, or about 2.2%. The decrease drives the need for spending increases: An oil and gas company only grows in value by growing reserves and production.
Although crude oil prices may be choppy throughout the summer, the general direction for oil service shares will be higher, says Steve Schwartz, an analyst at Circle T, a New York hedge fund. His fund has been stocking up on names that will benefit from rising land and shallow-water rig counts, areas expected to rebound fastest.
He likes Nabors, R&B Falcon (FLC:NYSE), which has a large shallow-water fleet, and shallow-water driller Ensco (ESV:NYSE). Increased rig counts and the full effects of the OPEC cutbacks later this year will provide a catalyst for shares to move higher, he says.
Current estimates for spending on exploration and production and oil service earnings may be too conservative, says Pickering at Simmons. Not only have the cash flows for exploration and production companies improved from the recent rise in oil prices, but also stable oil prices have opened the door of the capital markets to energy.
More than a dozen companies, from BP Amoco (BPA:NYSE) to Kerr-McGee (KMG:NYSE) to small independent Pogo Producing (PPP:NYSE) have tapped the public debt and equity markets since April. Capital infusions will undoubtedly be spent to lower debt and make acquisitions -- both properties and companies -- but will also find their way into exploration budgets, Pickering says.
Eventually, larger exploration budgets translate to increased revenue for oil service companies. Simmons recently upped its estimates for exploration and production spending growth for 2000 and 2001 to 15% annually from 6% to 8%. Revenue increases for oil service companies are expected to increase on a similar scale. And as Mike Simmons, an industry consultant and publisher of industry newsletter Offshore Drilling Bits points out, many oil service companies have cut costs, so revenue increases will have a bigger impact on the bottom line.
In conjunction with that, analysts -- who got badly burned by being overly optimistic as the group plunged -- will probably start to revise earnings estimates upward, which would be another catalyst to bring more investors into the group and drive shares up. Earlier this month, Simmons raised its 2000 estimates for seven large- and mid-cap service companies by 22%.
Of course, if oil falls back below $15 a barrel, confidence in the strength of the recovery would be greatly diminished. And every month oil remains at current high-teen levels brings the danger that OPEC members could cheat on current quotas.
Secondly, bulls could be overestimating the confidence on the part of oil companies -- exploration and production spending may not ramp up so quickly.
A third factor, according Pickering at Simmons, is investor sentiment. After all, the group looks expensive.
But for now, investors are betting the stocks have plenty of juice left in them.
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