Update: Rowan's Upside Surprise Can't Lift the Gloom in the Oil Patch

Rowan (RDC) Wednesday beat Wall Street's depressed outlook for third-quarter earnings as its drilling and aviation-services segments performed strongly. The oil-services firm also set plans to sell 10 million common shares.

For its third quarter ended Sept. 30, Rowan earned a penny a share, beating the Street's estimate for a break-even quarter but falling sharply from the year-ago 38 cents, as revenue shriveled to $120 million from $183.5 million a year earlier. Rowan's legal feud with BP Amoco (BPA) continues to depress results.

The following story was posted at 7 a.m. EDT:

Oil Drillers See Light at End of Tunnel, but Results Still Look Dim

This spring, Rowan (RDC) couldn't pay oil companies to rent rigs in the Gulf of Mexico: At the end of March, just a third of its 15 available gulf rigs were under contract.

Now, as the domestic offshore drilling market rebounds, Rowan has virtually all of its gulf rigs working, and some rig-rental rates are nearly double their early 1999 levels. That signals good things for U.S. oil drillers' earnings heading into the new year, analysts say, though third- and fourth-quarter results will likely continue 1999's dismal trend and an international turnaround remains elusive.

Rowan isn't alone in seeing dramatic increases in rental rates. Drillers including Ensco (ESV), Global Marine (GLM) and Noble Drilling (NE) are seeing a turnaround that began with March's OPEC-led oil-production cutbacks and the subsequent oil-price rebound. Although the turnaround has been slower than many expected, the tone of these companies' earnings conference calls this week should be decidedly more positive than in recent quarters, observers say.

Steadily increasing rig counts and expectations of greater oil company spending should fuel bottom-line gains throughout the service industry beginning in 2000's first half. Deutsche Banc Alex. Brown, for instance, estimates that service companies will see earnings jump 38% next year, partly reversing this year's stark 70% decline.

The brightening outlook led James Crandell at Lehman Brothers Monday to increase 2000 and 2001 earnings estimates on four drilling contractors and upgrade his investment ratings. Crandell now expects Rowan to earn 20 cents rather than lose 10 cents next year, and in 2001 he estimates Rowan will earn 90 cents, up from 60 cents. The First Call/Thomson Financial consensus estimates call for Rowan to earn 30 cents per share next year and $1.27 in 2001. The Lehman analyst, whose firm hasn't performed recent underwriting for Rowan, also upped Rowan to outperform from neutral.

"We've been extremely surprised over the strength in where day rates are being quoted," Crandell says.

The upgrade sparked a rally in the sector Monday, reversing a month-long slide that drove the Philadelphia Stock Exchange oil service index to 67.64 at Friday's close from around 90. Rowan shares rose 9% Monday and added 1/8 to close at 16 9/16 Tuesday.

Ducks in a Rowan Rowan shares' movement tracks that of the oil-services industry

Source: BigCharts

At this point, however, it's unlikely the higher rig-rental rates will affect 1999 earnings for the drillers, since many rigs are still working near break-even rates. Rowan, which is scheduled to report Wednesday, is expected to break even for its third quarter and to lose a penny per share in the fourth quarter.

Still, this year's losses are old news to investors, who want to hear about the future, not the past. "The clients I deal with ... are not ecstatic about watching their holdings go down 30%," says Robert Trace, who follows the group at Southcoast Capital, of the sector's recent rout. "But they're not freaking out. They have a perception that things are different [from late 1997 and 1998]. Asia is not falling apart as it was two years ago."

Utilization for the entire Gulf fleet of 190 rigs is 74%. For the 141 jack-ups currently in the Gulf, utilization stands at 76%, but even that figure belies the area's strong fundamentals, says Tom Marsh, drilling editor at Offshore Data Services, a Houston publisher that tracks rig markets. "The implication is there are a number of rigs available, but that's not really the case," he says. Most of the available rigs are smaller and capable of drilling only in water up to 200 feet deep.

To be sure, drilling day rates may not shoot straight up from current levels. Analysts are worried about the temptation for contractors to return idled rigs to work in the Gulf, increasing the drilling capacity. "We may be hitting a near-term ceiling in the Gulf for day rates" as contractors shift capacity, says Wes Maat, an analyst at Deutsche Banc Alex. Brown.

But companies may not be so eager to repeat the market-share wars that drove rates down precipitously throughout 1998's second half. Fifteen of the 27 or so idle rigs in the Gulf belong to R&B Falcon (FLC), and Vice President Charlie Ofner says his firm is in absolutely no rush to bring those rigs to the market: "We're going to be disciplined and not bring out any rigs until we see significant margins and longer work periods."

Another caveat is that the Gulf of Mexico market, driven primarily by natural-gas drilling in its shallow areas, is not reflective of worldwide drilling activity. Independent oil and gas companies now control substantial acreage in the shallow waters, and are considered more flexible with spending plans than the majors.

Internationally, the majors still account for the majority of spending, and important markets such as West Africa and the North Sea still experienced declines in September. Still, West Africa may turn around beginning in the first quarter, says Crandell at Lehman. The North Sea is more of a question mark, but observers forecast a turnaround later in 2000, possibly in the third quarter.

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