From Dain:
U.S. CAPITAL SPENDING HIGHER THAN ESTIMATED; PRICING IS KEY
This time last year, surveys showed that an 18%-22% spending increase was
expected for 2000 vs. our forecast of a 31%-33% spending increase, based on a
model we use. Actual spending was up 48%. This same under-expectation is
occurring once again this year. In the popular surveys, oil companies based
prospect economics and cash flow generation of natural gas and oil based on
prices lower than are currently being realized. Since the focus is on
production growth and the fact that independents reinvest free cash flow, any
higher cash flow generation versus expectation is likely to be reinvested.
Any expectation that much of the independents' cash flow would be dedicated
to buying properties up for sale by the majors is being dashed as well with
virtually no properties for sale and majors indicating the opposite, being
better buyers (Shell/Barrett).
At our Mini-Energy Conference in Houston, Texas, a number of E&Ps talked
about budget levels of this year, and most talked higher numbers. Kerr-McGee
Corporation (NYSE: KMG; SB-Agg; $69.79), Anadarko Petroleum Corporation
(NYSE: APC; SB-Agg; $70.57), Noble Affiliates (NYSE: NBL), Mitchell, and
Newfield (NYSE: NFX; SB-Agg; $39.19) all plan to increase spending by 40% or
more. A survey of 16 leading independents shows an increase closer to 35%.
The total number of rigs that can be put to work this year would increase the
total by no more than 15%. Against a 35% spending increase, this implies that
pricing will move up by 20%. This is probably close to correct and has a
significant impact on EPS estimates and price targets of oilfield service
companies.
An interesting point was made during a presentation by an E&P company at
our conference. Asked about land rig dayrates, he stated that he had two rigs
operating, let one go, and will be back up to five in a month. The rig
dayrates range from $10,000 to $14,000 a day. The rig that was let go was
being raised to $18,000. The CEO stated that it was a bad financial decision.
With 90 days of drilling, a $2,000 increase in the previous dayrate means
$180,000 of additional cost on a $3.5 million well which isn't critical, and
availability of rigs combined with these economics makes keeping the rig at
the higher rate a good economic decision. But the CEO said that you have to
say 'no' to contractors occasionally just to keep them honest. He also said
that he thought well costs this year would be up 20%-25%. That isn't any
indication of more rigs working. That is just the increase in pricing for all
goods, services, and equipment used in drilling and completing a well, which
argues for, and confirms, our expectation of the 2001 pricing increase in
many sub-sectors of the OFS group.
BJ Services Company (NYSE: BJS; SB-Agg; $82.42) will have raised domestic
pricing by 26% in a six-month period, a higher level than any analyst or
investor would model. Those price increases just get BJS share pricing back
to early 1998 levels, adjusted for inflation, and those prices still didn't
justify significant capacity additions to the capital asset fleet. We have
seen an approximately 20% price increase for land contract drillers from the
third quarter of last year to today, and the annual averages will show that
level or slightly higher.
Virtually no analyst or investor generally or currently includes
significant price increases in most models, since respective management won't
confirm those expectations in advance of implementation. Just as analysts
lower numbers constantly on the down cycle, since pricing erosion has a much
greater impact than lowered activity forecasts, estimates and price targets
escalate at this point in the cycle as the leverage from pricing is factored
in.
The point of this is that expectation of higher pricing is not anecdotal.
Company budgets should increase by approximately 35%, based on public
statement. Commodity pricing is staying high enough that there is little
current risk to these budget statements. The number of rig reactivations is
based on public statements by companies and is supported by continual
industry surveys and studies showing capacity, the number of rig yards, and
other factual reviews. Pricing is already moving up. Pricing accelerates up
through a cyclical industry's recovery.
So not only is spending by oil companies (oilfield service company
revenues) expected to increase; it is likely to increase at a faster rate, to
a higher level, and significant data and a great deal of history exists to
confirm this.
This means that revenues and earnings in most models are too low and that
earnings have much greater upside relative potential than the revenue
increase due to margins expanded by price increases rather than just
utilization-driven incremental gains.
Stock Opinion
Rig companies, product/service companies, and rental companies all stand out.
Manufacturing generally is not at the same utilization level yet; the same
can be said of seismic and construction. In these sub-sectors, activity is
picking up, but the pricing inflection point has not yet been reached.
We recommend that investors focus on the following:
((Land Drillers:))
((Patterson Energy))--(Nasdaq: PTEN; SB-Agg; $38.39) $54 target - 9x
EV/EBITDA multiple, the mid point of the comp's 2000/2001 current multiple,
of our 2002 EBITDA estimate of $233 million.
((Nabors Industries, Inc.))--(AMEX: NBR; SB-Avg; $61.50) $80 price target--
a 25x multiple of our 2002 EPS estimate, a conservative historical trading
range during recovery cycles.
((Keg Energy Services Inc.))--(Nasdaq; KEG; SB-Spec; $12.75) $22 target--
11x EV/EBITDA multiple for 2001, which is in line with its contract land
peers.
((Grey Wolf, Inc.))--(AMEX: GW; B-Agg; $6.88) $11 target--a 9.5x EV/EBITDA
multiple of our 2002 EBITDA estimate of $236.8 million, a slight discount vs.
peers due to debt.
((UTI Energy Corporation))--(AMEX: UTI; SB-Agg; $37.52) Target of $43--a
9.5x sector recovery EV/EBITDA multiple applied to our 2002 EBITDA estimate
of $181.7 million. Applying a conservative 25 multiple to our 2002 estimate
of $2.27 yields a price of $57.
((Service Companies And Tubular Manufacturers:))
<ul>*((BJ Services Company))--(NYSE: BJS; SB-Agg; $82.42) Target is $95--an
average of the peer group's EV/EBITDA for 2001, 12.8x, and a trailing
multiple of 15.5x.
*((Lone Star Technologies, Inc.))--(NYSE: LSS; SB-Agg; $47.25) Target of
$66--applying a small- to mid-cap comp group multiple of 26x to our current
2001 EPS estimate of $2.50.
*((OSCA))--(Nasdaq: OSCA; Buy-Spec; $24.56) $27 target--16x multiple of our
2002 earnings estimate, in line with the peer comps.
The following companies have relatively less direct exposure to the current
cycle; they're dynamic but with excellent potential:
*((Baker Hughes Inc.))--(NYSE: BHI; SB-Avg; $44.07) Our conservative 12-
month target of $45 is derived by applying a 38x multiple, at the low end of
the company's recovery cycle trading band, to our 12-month forward EPS
estimate of $1.20.
*((Varco International Inc.))--(NYSE: VRC; SB-Avg; $44.07) Target of $27--
12x EV/EBITDA multiple observed at last year's seasonal high. The $35 top end
of our range recognizes Varco's late-cycle bias, attributable to the nature
of its Rig Products business.
*((Cooper Cameron Corporation))--(NYSE: CAM; B-Spec; $67.85) $80 target--a
17 multiple of EV/EBITDA for 2001 and the same multiple of 2002 EBITDA with a
one-year 15% discount, which is its historical peak-leg cycle multiple.
*((Weatherford International, Inc.))--(NYSE: WFT; B-Agg; $58.01) Target of
$65--a 13 multiple of 2001 EBITDA and a 10 multiple of 2002 EBITDA, in line
with the current valuation of the group.
*((NOI)) (NR)</ul>
In our opinion, the following are not yet a compelling value:
<ul>*Schlumberger Ltd.--(NYSE: SLB; Neutral)
*Halliburton Company--(NYSE: HAL; Neutral)</ul> |
