Another article scalped from AOL board:
Bad news for big oil companies creates buys among oil services
stocks. Still, uncertainty will create choppiness in the sector - and some
stocks will suffer"
By Michael Brush
Among the darlings of Wall Street for much of 1997, oil service
sector stocks took a big plunge Tuesday along with the major oil
companies, which were downgraded sharply by analysts.
Earnings forecasts at the big oil companies like Texaco (NYSE:
TX), Exxon (NYSE: XON) and Chevron (NYSE: CHV), among others, were
slashed because of fresh fears that oil prices are headed down in
1998.
Oil service stocks, which supply things like rigs and drilling
equipment to the big oil companies, went along for the ride for
one simple reason: a rule of thumb among the sector's analysts,
which holds that the fortunes of oil services stocks can be
predicted by the forecasted exploration and production budgets at
the big oil companies. When profits at those big oil companies
are going down, it stands to reason they will be cutting back on
exploration and production. And if that's the case, investors
figure, better sell all oil service stocks.
Anyone who was trimming oil service stocks across the board
Tuesday on the basis of this logic, however, was making a mistake
-- and creating a good buying opportunity for investors with a
better understanding of the sector.
Sure, things look bleak for oil stocks. Many of the Pacific Rim
countries -- which as a group account for about 27% of world oil
demand -- are facing a big economic slowdown. OPEC just increased
production quotas in November. Iraq soon may be able to double its
production. Non-OPEC supply is increasing overall. And El Nino or
no, it looks like much of North America will have an unseasonably
warm winter this year.
All these factors have convinced Mike Rabalais, an oil analyst
with Robinson Humphrey Co. LLC, to adjust his 1998 worldwide oil
demand outlook down to about 2.2% growth, from a forecasted 3%
growth before the summer. Oil analysts at Merrill Lynch figure
global oil supply will exceed demand 76.7 million barrels a day to
75.6 million a day, this year.
This kind of imbalance is why Brown Brothers Harriman oil analyst
Benjamin Rice thinks the price of a barrel of West Texas
Intermediate will average $18.75 in 1998, down sharply from 1997.
And compared to some analysts, he is on the optimistic side.
All this seems to spell gloom and doom for the oil services
stocks. "The bear case for oil service sector stocks is that if
exploration and production companies have sharply less revenue,
they will spend less," says Rabalais.
But much of this is an overreaction. "Oil stocks are not seeing
earnings estimates come down across the board," points out
Rabalais. Indeed, says Ed Keon of IBES, which tracks earnings
estimates revisions, profits for the group are down just .8% in
the past month, compared to a decline of 1.4% for the S&P 500
stocks.
And at least three types of oil service stocks should continue to
have downright decent revenue growth, despite the turmoil in the
sector, analysts say. That's because they are in pockets of the
sector where growth will be strong. These include the following:
* Deep water drilling companies Oil strikes in shallow water tend
to be smaller than those in deep water. And getting the oil out at
shallow water sites can often be less economical. Deep water
projects, on the other hand, tend to be much larger, multi-year
projects. As such, they are less sensitive to short-term movement
in oil prices. Given this, companies like Diamond Offshore (NYSE:
DO), which focus on deep water operations, should continue to
perform well. The recent selloff of this stock may present a good
buying opportunity.
* Companies with international exposure While many of the big oil
companies are restricting the amount they will be spending on
exploration and production at U.S. sites, that's not the case for
foreign operations. Royal Dutch (NYSE: RD), for example, is
increasing its exploration and production budget by 20% in 1998.
Given this, say analysts at Merrill Lynch, investors should look
for companies with more than half their earnings coming from
outside the U.S. Rabalais says Camco International (NYSE: CAM) is
a solid example in this category. Another is Cliffs Drilling
(NYSE: CDG). Although many of its rigs are in shallow water, it
has done a good job of increasing its international exposure at
premium rates, mainly in Latin America.
* Capital equipment companies Over-building in the oil services
sector in the late 1970s and early 1980s means that much of the
equipment in use today was made back then. Now it is wearing out,
making capital equipment makers a good play. Rabalais says
National Oil Well (NYSE: NOI) is a good example. EVI Inc. (NYSE:
EVI) is another company in this field that continues to have solid
earnings revisions.
Oil services companies that are suspect because they have too much
U.S. or land drilling exposure include Nabors Industries (NYSE:
NAB), Patterson (NASDAQ: PTEN) and Cross Timbers Oil (NYSE: XTO).
If you invest in the sector, be warned that things can be as
volatile as the price of oil -- which generates the revenue that
goes into exploration -- and that can be pretty volatile. "Rolling
a hand grenade out of a car in Saudi Arabia at the wrong time in
the wrong place can make the price of oil go up for a couple of
months," says Rice, of Brown Brothers Harriman. Things like
weather and geopolitical tensions, of course, are also big
factors.
Indeed, this kind of volatility, and the uncertainty surrounding
analysts' expectations about the price of oil and earnings at the
big producers, has Louis Navellier uncertain about the oil
services sector. The portfolio manager of Navellier Securities
thinks fourth quarter 1997 earnings will be strong. And once those
earnings are announced, he plans to sell into strength in these
stocks.
He plans to reduce his position of about six oil service stocks
down to two -- probably Cliffs Drilling and EVI. He thinks many of
the companies will continue to do well. But the Wall Street
analysts have cast a shadow over the sector. "I really think a lot
of the industry is fine," he says. "My problem is the analysts
are ignoring me right now. It is not smart to fight Goldman
Sachs."
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