From Barrons online weekday trader:
Weekday Trader
Time to Call in the Marines?
By Vito J. Racanelli
Oil service stocks certainly deserve the Jekyll-and-Hyde award for the way
they have acted on Wall Street this year. When crude oil prices rise, the
shares rally, only to quickly turn ugly when prices fall.
But is this their moment?
Oil prices appear to have stabilized at $15 to $16 per barrel, after
falling from about $22 last fall. And Baker Hughes's (BHI) offer this week
to buy Western Atlas (WAI) is just the latest in what has become a wave of
mergers among drillers and oilfield equipment providers.
Yet the stock prices haven't caught up with the improving fundamentals.
Drillers, for example, sell at an average 15 times 1998 consensus earnings
estimates and at 11 times 1999 projections. If oil prices have indeed hit
bottom, Wall Street's confidence in these companies' earnings should
improve significantly. And that should help some oil service stocks that
still look undervalued, like driller Marine Drilling Cos. (MDCO) and Halter
Marine Group (HLX), which builds and refurbishes oil rigs, as well as
seagoing vessels for various industries.
Marine Drilling's stock tanked earlier this year when the company reported
first-quarter earnings that were three cents below consensus estimates of
35 cents per share. That came mainly on lower-than-expected drilling
earnings and higher expenses and taxes. Its stock price now languishes at
$23 1/4 a share, far below its 52-week high of 36 1/16, set last October.
But Marine Drilling is quietly reinventing itself. True, most of its rigs
are located in the shallow waters of the Gulf of Mexico, where day rates
are still pretty weak. But the company is quickly moving to the safer,
deep-water drilling areas (3,000 feet or more below the sea surface).
There, rig contracts tend to be longer and jobs much less exposed to the
vagaries of oil prices. (See "Deep Sea Diving For Bargain Drillers,"
February 4, Barron's Online.)
That move will provide better "earnings stability," notes Hanifen, Imhoff
analyst Jack Collins. Deep water drilling will account for some 40% of
Marine Drilling's sales in 1999, four times the 10% of revenues it
comprised last year, Collins says. Ryan Crane, a senior analyst with AIM
Capital Management, which owns about 2.5 million Marine shares, agrees that
Marine Drilling is "moving up the food chain."
But Wall Street still views the company as just another shallow-water Gulf
driller: The stock is changing hands at about 15 times First Call's
consensus 1998 estimates of $1.54 a share, in line with that group but
selling at far less than the 18x multiple for 1998 that deepwater drillers
command. Based on next year's earnings, the disparity is even wider: Marine
Drilling sells at less than nine times consensus estimates of $2.67 a share
for 1999. That's well below both the 11x average for plain-vanilla drillers
and the 14x P/E deepwater drillers get.
That relatively cheap price ultimately could add to Marine Drilling's
allure as a takeover target. Hanifen, Imhoff's Collins, for example,
believes that as a smaller player with a respectable rig fleet and a clean
balance sheet, Marine Drilling is a logical candidate for a larger driller
looking to bulk up. His target price for the stock is 32.
Drillers got the most attention during the recent oil service selloff, but
oilfield equipment stocks went south as well. Among them was Halter Marine,
which some investors say looks promising now.
The company had all kinds of problems in the fourth quarter of its fiscal
year ending in March. Weather-related delays, a bloated workforce and heavy
overtime payments combined to drive earnings down to a piddling two cents a
share, far below analysts' original estimates of 29-30 cents, notes Furman
Selz analyst Stephen Gengaro.
That shook Wall Street's confidence in Halter's management, Gengaro adds,
and down went the stock: Halter's shares lost some 40% of their value,
dropping from about 25 in late January to 14 after the earnings report
came out.
The stock price has edged up a bit: It now trades at 18 1/4, but still
well below half its 52- week high of 41 1/2 in early November. At that
price, Halter stock changes hands at 16 times estimates of $1.15 per share
for the fiscal year ending March 1999, and at 11x fiscal 2000 consensus
estimates of $1.66 per share. In comparison, Friede Goldman, a pure play
in rig construction and a Wall Street darling, sells at 29x 1998 consensus
estimates and at 19x 1999 projections, with estimated earnings growth of
about 51% next year.
But Gengaro, who has a Buy rating on Halter and a target price of 30 within
12 months, says the problems are probably behind the company now. Its order
backlog at the end of fiscal 1998 was $817 million -- up from $244 million
in March 1995 and Halter's highest backlog ever. And since the end of
fiscal 1998, Halter has signed two more contracts valued at about $170
million to build two deepwater drilling rigs for Petrodrill Construction Inc.
The outlook for rig repair and construction in the energy services market
-- where Halter earns its highest gross margins -- appears strong. Tom
Marsh, managing editor of Offshore Data Services, a Houston-based industry
publisher, says that some 238 of the world's 380 or so jackup rigs are 16
years old or older. (Jackup rigs are used in relatively shallow water.) As
a rig approaches 20 years of use, drillers have to decide whether to build
or refurbish it. That's good news for Halter either way, because it means
"money is going to be spent" on the bulk of the world's rig fleet, says
Marsh.
Higher oil prices would certainly be the magic elixir that would push this
group's stocks higher. But even if crude stays right where it is, stocks
like Halter Marine and Marine Drilling appear to have much more upside than
downside.
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