Oil Estimates Could Continue Downward Spiral

As John Lovoi of Morgan Stanley Dean Witter said in a report this week on the oil-service sector, "the second half of 1998 has been a disaster."

Activity and services in the oilfield have declined throughout the third and fourth quarters right along with the price of West Texas intermediate crude, which hit a low of $10.72 earlier this month.

Given this, a rash of earnings-estimate reductions began in mid-third quarter and continued through late November as oil companies began paring down their spending in earnest. But it looks as if a few fourth-quarter estimates are still too high. And 1999 estimates, in most cases, seem too optimistic.

"The magnitude of coming revisions will be profound," says Bill Herbert, head of oil-service research at Howard Weill in Houston.

One example: Smith International (SII). The First Call consensus estimate for the December quarter is 42 cents a share. Herbert's estimate is 35 cents, but he plans on cutting it to 25 cents after recent discussions with the company. Howard Weill doesn't rate individual stocks, and it hasn't performed underwriting for Smith. Smith officials were unavailable for comment.

Overall, fourth-quarter earnings for the drillers are expected to fall 34% year over year, says Chuck Hill, First Call's director of research, while the Dow Jones universe of oilfield-equipment companies is expected to decline 30%. Hill expects fewer negative surprises this quarter relative to the broader market because analysts have gone a long way toward reducing their estimates.

But of more concern to investors at this point is what will happen next year.

"Why is next year going to be better than the fourth quarter?" asks Mike Nery, a vice president at energy hedge fund Denver Energy Advisors. All the major indicators -- including rig counts and oil prices -- point to continued weakness. So any 1999 estimates that are more than four times current fourth-quarter estimates are too high, he says. And if investors are looking to current estimates to determine 1999 price-to-earnings ratios, they need to re-evaluate, he adds.

Deep Enough? Earnings estimates for drillers 4Q Year Company 1998 1997* 1998 1999 Falcon Drilling (FLC) 19c 41c $1.19 $1.10 Marine Drilling (MRL) 12c 35c $1.14 34c Global Marine (GLM) 23c 48c $1.30 89c Transocean Offshore (RIG) 81c 36c $2.96 $2.99 Diamond Offshore (DO) 56c 55c $2.63 $2.02 Rowan (RDC) 11c 60c $1.48 94c Ensco (ESV) 15c 56c $1.68 29c Santa Fe (SDC) 60c 60c $2.38 $1.72 Noble Drilling (NE) 26c 35c $1.24 $1.26 Pride (PDE) 32c 37c $1.52 $1.06

*Actual data. Source: First Call, estimates as of Dec. 17.

Even the large-cap oil-service companies are in a tough position, Herbert says. Schlumberger (SLB) will be lucky to earn $1.25 in 1999, he says. The current consensus estimate stands at $2.15. His firm hasn't participated in any recent Schlumberger underwriting projects.

Gary Yamamoto, a Schlumberger spokesman, declined to comment specifically on earnings. But, he says, "The drop in oil prices will cause increased activity slowdown, which may have continued downward pressure on earnings."

Other oil-service executives are fairly comfortable with fourth-quarter estimates, but much less so with estimates for 1999. Many declined to comment on 1999 estimates, citing the uncertainties of oil prices and continued deterioration in rental and utilization rates heading into the first quarter.

"We'll get close" to the fourth-quarter consensus estimate of 23 cents, says Dave Herasimchuk, Global Marine's (GLM) vice president for market development. The variable for Global Marine is its turnkey, or drilling-management division, ADTI. Houston-based Global won't be sure of the revenue from its ADTI division until the quarter is closed. "But 89 or 90 cents for 1999 is too high," Herasimchuk adds. "The business is getting worse."

Soft Serve Earnings estimates for oil-service firms 4Q Year Company 1998 1997* 1998 1999 Schlumberger (SLB) 54c 71c $2.54 $2.15 Halliburton (HAL) 36c 58c $1.81 $1.85 Baker Hughes (BHI) 19c 34c $1.10 91c Weatherford (WFT) 38c 58c $2.09 $1.55 Smith International (SII) 43c 75c $2.25 $1.70 BJ Services (BJS) 19c 52c $1.67 $1.02 Varco (VRC) 24c 29c $1 72c Cooper Cameron (RON) 68c 86c $2.79 $2.09

*Actual data. Source: First Call, estimates as of Dec. 17.

Global recently has cold-stacked, or removed from the market, two shallow-water jackup rigs in West Africa, Herasimchuk says, a foreboding sign for the international drilling market. The coming year looks pretty grim on the international side, he says, especially in key markets such as the North Sea and West Africa. With North Sea Brent crude, the European benchmark grade of the slippery stuff, trading at $10 per barrel, "it's shutdown time for most of our customers."

Future oil prices, which will determine oil-company spending and demand for oil services, are the key variable and will be a major factor in determining rig rental rates. If crude oil stays depressed throughout 1999, drilling contractors will also be faced with deciding whether to pull idle rigs off the market. That serves to decrease the number of rigs earning cash in analysts' revenue models. Crude oil for January delivery traded at $10.95 per barrel, sinking 8 cents even as U.S. and British missiles struck Iraq.

Caren Steffes, a Diamond Offshore (DO) spokeswoman, says Diamond has given little guidance to analysts on its 1999 revenue numbers because of these variables.

"We can't assume day rates are going to increase," she says. She adds that the 56 cents Diamond is expected to earn this quarter is more reasonable than the 60 cents estimated just a few weeks ago. Likewise, some former 1999 estimates in the $2.60 and $2.70 range were "extremely high," she says. The present estimate of $2.02 is more reasonable.

The issue facing investors is deciding how much of this bad news is already in the stocks. For this group, "the incremental shock value of bad news is dwindling," says Herbert at Howard Weill, adding that he doesn't see a tremendous amount of downside.

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