NEW YORK (
) - In third quarter earnings, the themes that played out among oil service stock like
Oil service stocks are a basket trade come earnings.
Event-driven traders like to sell these stocks "on the news" and take profits.
North American market conditions were strong, as expected.
International market recovery remained an open question.
Sector fundamentals included cyclical upside, and oil service stocks levered to the trend.
Yet even though analysts and investors expected North America to be the bright spot in the third quarter -- and for the international outlook to remain open to debate -- when the stocks followed through on these themes exactly in the numbers and the commentary, the oil-service basket stock trade was a selloff. What's more, after the selloff, the stocks rallied to new 52-week high levels.
There's a fair chance this dynamic plays out again in the oil service stocks as earnings season kicks off with Schlumberger fourth quarter earnings on Friday. Schlumberger always sets the trend for the sector, as it's several times the size of any of its competitors.
The dichotomy between strength in North America and uncertain recovery internationally remains the fundamental thematic divide for the oil-service stocks. Since in the previous quarter this was the case, and the stocks still sold off after the companies reported more or less in line with expectations, what's the difference maker this time around?
For one, all the oil service stocks rallied to end 2010, hitting fresh 52-week highs at year-end, and even though the rally has abated a bit and the stocks come down from those 52-week high levels, there's still plenty of room for profit-taking "on the news" from the event-driven traders when Schlumberger reports on Friday.
The price of crude may be taking it on the chin on Thursday -- with Schlumberger notably the leader among intra-day losers in the group -- but that's less an issue for the oil-service stocks than the tone they set about international markets and earnings in 2011 and 2012, says Colin Gerry, analyst at Raymond James. Gerry thinks that as long as oil is trading somewhere between $80 and $100, there's general confidence in the markets. It was when oil jumped from $35 to $70 that investors were questioning whether the business fundamentals really supported the rally, but that's no longer an issue, meaning that the "North America vs. international market" dichotomy and the profit-taking impulse for stocks still near 52-week highs are the catalysts for earnings action.
Alan Laws, BMO Capital Markets oil analyst, agrees, saying that North American results will again be strong, as expected, and that what investors need to see is an international recovery well underway. The BMO Capital Markets analyst also believes that the impetus for a profit-taking selloff remains an earnings season factor, but he is betting that the oil service stocks are less "hyper-reactive" than they were after the third quarter reports. "Last quarter there were more expectations built in," the BMO Capital Markets analyst maintains.
The Raymond James analyst isn't in agreement on this point, saying that his biggest fear remains that the Street has "bulled up" too much about the international recovery, again setting the stage for the oil service stocks to disappoint even if they more or less say what they've said in the past about international delays amid a generally strong market outlook.
"I don't think numbers matter as much as tone. That's the art, not the science, and when you look historically at these stocks when the rig counts in North America are strong, we see a selloff on strong earnings. We see that trade all the time," Gerry notes. "The hard part for energy investors is grappling with prospect of profit-taking causing a pullback in the stocks."
In any event, both BMO Capital's Laws and Raymond James' Colin Gerry say the way for the long-term investor to play this event, if it occurs, is to wait for the oil-service stocks to take their hit, and then buy on the fundamentals. If Schlumberger takes a hit on earnings, it's likely the rest of the group will fall in line when they report, but it's also likely that once the dust settles all the stocks will recover and even reach new 52-week highs within a month.
BMO upgraded Baker-Hughes to a buy on Thursday, and raised prices across the board for the group, Laws said.
"The stocks aren't going to double or triple from here, but there is still upside," says Raymond James' Gerry. "As we came into 2011, we started thinking this is a textbook 'buy on the rumor, sell on the news' situation again, since these stocks had such big runs in 2010. Every time there's profit-taking here, the stocks rip shortly thereafter," the analyst adds.
All the oil service stocks could take their pain tomorrow if Schlumberger sells off on its outlook -- though last time around each one took its pain individually when it reported. However, the analysts believe the more important catalysts for another leg up from recent 52-week high levels isn't likely to be in the earnings. It's the 2012 earnings outlook and potential upside that will be delivered later in the year, and that will serve as a potential trigger for more bullishness on these stocks, short a major change in international outlook in the earnings commentary.
Schlumberger, in particular, will be holding its bi-annual investor day in February, and that's when the outlook will become more specific from the bellwether oil service stock. "They may fall on strong earnings like we saw last time, but the game we are really playing now is about upside to current Street 2012 earnings models. I think there's upside, but I don't expect the oil service companies to get more specific until Schlumberger's investor day," the Raymond James analyst Gerry concludes.
-- Written by Eric Rosenbaum from New York.
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