energy group last week stuck its neck out and called the bottom in oil service stocks, raising some stocks in the group along with some eyebrows.
Investors on Thursday and Friday used the opportunity to buy the group. The oil service index added 15% in the latter part of the week to close at 62.92, its highest level in three weeks, while stocks such as
outdid the OSX benchmark. SII jumped 25% Thursday and Friday, to 25 7/8.
, which was upgraded to a strong buy by Dain, added 6.4% over the two days to close Friday at 51 1/8.
In calling the bottom a scant week before it hosts more than 130 companies at its annual energy conference, Dain is flying in the face of the industrywide bearish sentiment that has been growing throughout the summer. News of decreasing day rates, lower rates of rig use and the dearth of signs of life in crude oil market seemed to push the group to new lows each week. And even as Dain is calling for overweighting in the sector, bad news on oil company spending just keeps coming out.
Dain also cut its 1998 and 1999 earnings estimates in the sector. Dain's numbers are now below the
consensus figures for 1999. For instance, Dain cut its 1999 estimate for
by 29% to $1.44, which is well below the consensus estimate of $1.64.
Dain's rationale for cutting estimates even as it called the bottom is that its reductions will allow investors to judge the group in a worst-case scenario.
"We have reached an inflection point" in the oilfield service and exploration-and-production groups, said Dain's Jim Wicklund in a conference call last week. Wicklund added that the basis for the firm's call was not valuations -- the stocks have been "cheap for some time," he said -- but an improving outlook from the supply side of the crude oil market. He did emphasize that improvement would be slow.
The key to a recovery in earnings growth for the drillers and service contractors is a sustained recovery in oil prices. Oil companies could then boost capital budgets, rather than shrinking budgets as the big oils have this year.
Dain's Dallas and Austin, Texas-based energy team saw signs of stabilization in rental rates for drilling rigs and pricing for various oil-service segment activity. In addition, it cited extensive historical analysis of oil prices and share price performance of service stocks.
But other analysts in the sector seemingly weren't convinced.
"We're on this kind of seesaw, but the overall trend is still down," says Tom Marsh, an editor and drilling analyst at
Offshore Data Services
, a Houston-based publisher that tracks rig markets. "When you look at the number of rigs coming off contract in the fourth quarter -- in the jackup market 119 are coming off contract between now and the end of the year -- it's an awful lot of capacity for contractors to market in sort of the off-season anyway."
Salomon Smith Barney's
energy team, which also cut its earnings estimates for 1998 and 1999 about two weeks ago, laid out a further downside earnings scenario for the offshore drillers it covers in a recent report titled "Opportunity or Armageddon." The new numbers show drillers with large jackup-rig fleets as most susceptible to earnings contractions if oil prices don't recover. For instance, in the Gulf of Mexico,
operates the largest fleet of jackup rigs, which have legs that extend to the ocean bottom and are used primarily in water up to 300 or 350 feet deep. Salomon estimates its downside to be about 76% from its current estimate of $1.35.
, all with large jackup fleets, would also be hurt substantially in this scenario.
Least susceptible to continued low oil prices are
. Salomon estimates that even if low oil prices persist, Transocean's 1999 earnings may drop only 4%, from $3.60 to $3.45; it estimates Noble's earnings could potentially take a hit of 11%, falling from $2.25 to $2.
Taking that negative scenario into account has to be done if the "long-run oil price paradigm" turns out to be in the $12 to $14 range, the report said. However, Salomon is confident in a return to the $17 to $19 price level for crude oil, which would bolster exploration spending. As it stands, Salomon says that oil company spending may not even reach the 6% year-over-year growth in 1998 that it projected in July.
A buy sider jumps to the sell side
has beefed up its coverage in the oil service arena. Late last week, Kurt Hallead, who left San Francisco-based hedge fund
in August, joined its energy team.
Hallead's addition will allow Merrill to expand its coverage in the energy services arena, says Janet Rasmussen, who co-heads Merrill's energy service coverage with Kevin Simpson. Rasmussen covers the drillers and offshore support companies, while Simpson covers the oil service majors. Although Merrill is still working out the details, Hallead's area of coverage will include seismic firms and subsea construction-related companies, as well as certain drilling contractors and equipment companies. Two definites so far are
. Kurt's addition will round out Merrill's energy team, which also includes Constantine Fliakos, a highly regarded oil analyst.
Cambridge did not return calls seeking comment.