Look no further than
Superior Energy Services
for an example of the carnage in the oil-service sector. Superior's stock has been punished thanks to the company's small size and its recently canceled merger with
Now, ironically, tough times in the patch may actually be a boon for Superior, giving it the possibility of upside earnings surprises in coming quarters.
Shares of the Harvey, La.-based service firm are trading at about 2, down 83% since mid-April 1998, when the stock traded at a 52-week high near 12. The
Philadelphia Stock Exchange
oil-service index is off more than 50% in that period.
Superior commands roughly 50% of the Gulf of Mexico market for plugging-and-abandonment services -- industry jargon for cleaning up drilling sites, plugging wells and removing production platforms.
Activity in this niche, historically deferred in low-price environments, is expected to heat up this year for three reasons.
First and foremost, this type of work is nearly a necessity when companies sell drilling properties. And with the public markets virtually closed to oil and gas companies, cash-strapped firms need to raise money to continue drilling programs or meet debt obligations, making asset sales more likely.
Banks, tightening loan covenants, could force property sales so borrowers can meet obligations, marking a big departure from prior low-price environments in which lenders were generally lenient. And after a prolonged period in which sellers sought last year's (higher) values for their properties, buyers and sellers may be closer to agreeing on property values, analysts say.
Second, in re-evaluating projects, more producers are shutting down marginally profitable or money-losing wells. After a well is closed, the operator has 12 months to clean up the site, according to
Minerals Management Service
regulations. The MMS oversees all offshore drilling activity.
Lastly, there has been a surge in temporary plugging-and-abandoning work as wells are prepared for work at a later date.
"It makes sense that if you're cleaning up a property for sale, you do
plugging and abandonment work," says Steve Smith, an oil and gas analyst at
Dain Rauscher Wessels
in Houston. Asset sales "are going to be a big event this year." Smith does not follow Superior.
In the past three weeks, Superior has seen a big jump in requests for bids for this work, according to people who follow the company. Granted, all these bids don't turn into contracts, but even small increases in revenue could generate higher earnings. Superior's CEO, Terence E. Hall, who handles the bidding process, was unavailable for comment.
Neal McAtee, who follows Superior at
in Memphis, Tenn., estimates Superior will earn 20 cents a share this year. He projects revenue from the company's plug-and-abandonment work of between $25 million and $30 million, about 30% of its total revenue and roughly flat with 1998. But if its P&A work heats up this year, small percentage increases in revenue could drive big percentage increases in earnings, McAtee says.
"As little as $4 million or $5 million more in revenue, or just 5% over current revenue estimates, could drive Superior's earnings per share to 25 cents from 20 cents," he says.
For the nine months ended Sept. 30, revenue totaled $69.2 million, up from $33.3 million in the year-ago period. Net income rose 66% to $9.5 million, or 32 cents a share, from $5.7 million, or 28 cents a share, in the 1997 period. Superior's revenue growth reflects acquisitions. The company is expected to report year-end results in early March.
McAtee recently raised his rating on Superior to outperform from market perform for valuation reasons. (Morgan Keegan has not doneunderwriting for Superior.) The stock is trading well below its book value of $3.31 per share, and while there is potential for a rally on any good news on oil prices, there is little downside risk. Also, Superior has an attractive price-to-sales ratio of 0.80.
Superior's valuation has attracted investors. David Nierenberg, general partner of the
D3 Family Fund
, a Camas, Wash.-based private investment partnership, began buying shares of Superior shortly after the company announced the termination of the Parker merger in January. He says he looks for "the best micro-cap in deeply out-of-favor industries." Superior, with its market cap of just $58 million and average daily trading volume of 314,000 shares, fits the bill.
Nierenberg is well aware of the current environment in the patch, but he's willing to wait out the downturn. Investors with the stomach and the patience could easily see fivefold or sixfold returns, he says.
Since January, Nierenberg has accumulated 750,000 shares, or roughly 2.5% of the company. He likes the caliber of management, its clean balance sheet and its acquisition strategy, as well as the company's ability to remain profitable in light of dismal industry conditions.