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FoxDavies' Oilfield Services Sector Outlook

Published: 08:39 03 Feb 2012 GMT

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Please find below a recent summary of our outlook for the oilfield services industry as well as our investment stance. We are highly selective on our investment stance and note that fundamentals are very attractive although the sector is highly oil price sensitive but offers limited direct exposure to the prevailing European economic woes. The full report is attached and includes most relevant charts pertaining to the industry and sector.

Solid fundamentals prevail for 2012 supported by recent positive trading comments

The fundamental outlook for global oilfield services companies remains favourable, reflecting continuing rising global hydrocarbon energy demand despite macro-economic concerns, increasing oil/gas industry capital expenditure - 10-15% pa over the next 4 years- and expectations of relatively high oil prices- annual average greater than $85/bbl, albeit with volatility. (U.S. Natural gas prices have recently fallen sharply to around $2.6/BTU but following recent production cuts we are confident that pricing levels will recover in the near term.) The overall rig count is likely to be on a continued rising trend with strongest rises in the Gulf of Mexico and West Africa. These positive factors are supported by encouraging company trading updates, healthy order books, good cash flow generation and solid financial positions. Valuations are generally not over demanding. Our key Buy recommendations in the UK are Kentz (LON:KENZ), Hunting (LON:HTG), Petrofac (LON:PFC), and Wood Group (LON:WG).

Investment Recommendations- Stance highly selectivity; limited exposure to European economic woes but oil price sensitive

Kentz (LON:KENZ)is competitively well placed servicing a wide range of upstream and downstream markets and many geographies. The order book remains extremely promising, giving good earnings visibility. The positive trading statement supports sound fundamental prospects with an attractive risk/reward profile. Share price outperformance is likely to continue despite the strong performance in 2011. The securing of prospective business will be the key catalyst

Petrofac’s (LON:PFC) goal to double recurring 2010 earnings by 2015 is attainable and the backlog at around $10.6Bn is comparatively very healthy giving the group good earnings visibility from its backlog. The shares should see a more sustained outperformance in 2012.

Hunting (LON:HTG)has a strong competitive position owing to its product focus and global footprint. The group is a cyclical play on oil and particularly gas activity especially in the U.S.- the current weakness reflecting the low US gas prices. This provides an excellent entry level.  We believe that the shares are likely to outperform other UK oilfield stocks given the relatively favourable risk/reward profile.

Wood Group (LON:WG): The Group has an attractive and well positioned competitive standing, with strong market position. The risk/reward profile is now more favourable and this supports our still positive stance towards the stock.

Schoeller Bleckmann (FRA:SLL): The group is very well positioned in the directional drilling market, with a leading competitive market position with niche products based upon proprietary technology. The recent share price weakness correlates with the fall in US natural gas prices. We expect a rebound in the latter and consequently believe current share price levels as an excellent entry point.  Traditional metrics suggest a full valuation but our DCF valuation implies upside potential of around 10%.

Newpark Resources (NYSE:NR): Newpark is a well-positioned, mid-sized U.S. oilfield services company with most attractive growth opportunities in the U.S. gas shale basins and in international markets including the fast growing Far East and Brazilian market. This growth profile is not reflected in the undemanding and favourable valuation compared with its peers. 

Recent Newsflow – Recent outlook statements bode well despite European macro-economic concerns

Rig Count News. The Baker Hughes Rig Count is the key barometer for the oilfield services industry and in particular the drilling contractors. Last week’s data (week ending (27/01/12) remained positive for the industry as a whole. The U.S. Rig Count stood at 2008, unchanged on the previous week and up 276 year over year with the number of land rigs at 1949. The number of oil rigs stood at 1,225. Gas rigs stood at 777 down 3 as US gas prices remain low with the directional/horizontal rig count at 1,402. The Canadian rig count gained further momentum, up 29 on the previous week.

Kentz’s (LON:KENZ) end of year trading statement read most positively. In terms of outlook the company stated ’Overall, the outlook is very positive, underpinned by the solid project pipeline of our core clients, which gives us confidence for 2012 and beyond.” Revenues and profits for the full year 2011 were marginally ahead of consensus expectations. The group has a record backlog of US$2.40Bn at 31/12/ 11, up 50% from 31/12/10, underpinned by further new awards and natural growth on existing contracts. This backlog included 60% of reimbursable service contracts with significant opportunity for continued natural growth during 2012. In addition the pipeline of prospects is just over US$10Bn. The cash position remains strong at around US$223m, which supports continued growth, both organically and through acquisition.

Hunting’s (LON:HTG) year end trading statement was very positive. ‘Trading since the release of the IMS on 17 November 2011 has exceeded management's expectations particularly within our North American manufacturing and connections business units where demand continues to show strong momentum, together with excellent trading from our Asia Pacific operations. As a consequence 2011 full year earnings, which are still subject to external audit, are now expected to be above the top end of analyst expectations. Management are comfortable with the business outlook for 2012.’ This is despite the recent weakness in US gas prices.

Schoeller Bleckmann’s (FRA:SLL) preliminary 2011 results were very pleasing and above consensus. Group sales went up by 32% to EUR407M. Earnings before interest and taxes (EBIT) increased by 80% to EUR89M with an operating margin of 21.8%, up from 21.2% at the 9 -month stage. Earnings before taxes (EBT) rose 80% to EUR 77M. We believe these results underpin the likelihood of further good results in 2012. 

Petrofac (LON:PFC): Petrofac and Schlumberger announced recently that their Integrated Energy Services and Schlumberger Production Management divisions respectively have signed a Co-operation Agreement under which these divisions will establish a working relationship to deliver integrated and high-value production projects in the emerging and growing production services and production enhancement market Both companies will deploy their own capital in these production enhancement projects. The market opportunity for the collaboration is significant as major resource holders seek to develop discovered low-risk reserves against an industry environment characterised by a shortage of capability and capacity.

Schlumberger’s (NYSE:SLB) Q4 2001 results were broadly in line with market expectations. Income from continuing operations was $1.49 Bn—an increase of 13% sequentially and 28% year-on-year. Diluted EPS from continuing operations was $1.11 versus $0.98 in the previous quarter, and $0.85 in the fourth quarter of 2010. 2012 outlook comments were broadly encouraging. ‘‘Uncertainty remains over the outlook for 2012 due to the continuing sovereign debt crisis in Europe which places downward pressure on GDP and oil demand forecasts. Natural gas markets are well supplied in North America with gas storage well above five-year highs.  In this environment, the thin excess oil supply cushion is expected to support oil prices close to current levels, while global demand for LNG continues to increase. Recent E&P customer spending forecasts also point to higher E&P investment in 2012, particularly in international markets. Against this backdrop we are planning for growth in 2012, while building the required flexibility into our resource plans. We remain confident that any potential reductions in activity will be short-lived and that our competitive position remains strong, given our presence and strength in the international markets and the balance we have established between reservoir characterization, drilling and production services in our North America offering.”

Weir Group (LON:WEIR), the engineering solutions group, has agreed to acquire Novatech, a US manufacturer of well service pump valves and valve seats for upstream oil and gas applications, for $176m (£113m) in cash.  Subject to US regulatory approvals, completion of the acquisition is expected in February 2012. Novatech, a family-owned business, produces a wide variety of proprietary valves and valve seats for high pressure applications such as frac, cement and mud pumps used in unconventional upstream oil and gas operations.  Novatech achieved proforma revenues and EBITDA of US$61.6m and US$25.2m respectively for the most recent fiscal year ending 30/09/2011. The most relevant transaction multiples for the deal are of an EV/sales of around 3 times and an  EV/EBITDA of six times.

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