Tech Rally Pulls Limelight Away From Value-Rich Oil Sector

Many of these stocks offer solid value and an improving fundamental picture, analysts say.
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If tech and Internet stocks have been the market's darlings lately, then oil-service stocks have been the widows and orphans.

As the

Nasdaq

has zoomed to one record close after another, a midyear rally in oil-service stocks has fizzled. Even with last week's 7% jump in the

Philadelphia Stock Exchange

oil service index, the OSX has fallen 15% since mid-November.

With tech shares picking up steam, "you're seeing an exodus in the sector from growth investors that have played the commodity in the past year," says Brad Starkweather, director of oil and gas consulting at the

Carson Group

in New York, referring to oil's sharp advance this spring and summer. "They are moving money to technology and the Internet."

Yet with energy-sector fundamentals continuing to improve, investors who are chasing returns in tech may be missing out on an attractive investment opportunity, analysts say.

Money's Flowing

The erosion of interest in oil stocks is frustrating, Starkweather says, because with crude oil trading at a healthy $26-plus per barrel, companies are making more and more money. Higher oil prices, demand growth and drastically decreasing inventories all point to big earnings increases in 2000 and 2001, observers say.

"After the fourth quarter, you have the potential for eight solid quarters of sequential earnings increases," says Wes Maat, analyst and managing director at

Deutsche Banc Alex. Brown

in New York. "We're setting ourselves up for a nice cycle over the next three years. It just hasn't started yet."

More, with the oil service index still at the lower end of its recent trading range, many of the stocks appear more reasonably valued, unlike their Internet counterparts.

One Niche

In natural gas drilling, for instance, the outlook is very promising for service companies such as

BJ Services

(BJS)

and

Weatherford International

(WFT) - Get Report

, and drillers such as

Ensco

(ESV)

and

Rowan

(RDC)

.

In a research note Friday, for instance,

Merrill Lynch

analyst Kevin Simpson increased his earnings estimates for BJ's fiscal first quarter, ending in December, and fiscal year 2000. He raised his first-quarter estimate to 17 cents a share from 14 cents, and his fiscal 2000 estimate to 95 cents from 90 cents, saying in the note, "we still see room for further upside surprises."

His price target of 50 on the stock -- it closed at 37 15/16 Monday -- underscores his confidence, even though BJ currently boasts a price-to-earnings estimate of 39 based on his 2000 estimate, well above some industry peers. Simpson rates BJ a buy, and his firm has underwritten for BJ.

And even though the oil service index is up more than 30% this year, there is plenty of room to run: The OSX would need to double from current levels to match its late 1997 highs.

Bullish Data

As crude-oil inventories have plunged, crude-oil demand has risen, perhaps the most bullish evidence that an earnings recovery in the service sector can't be far off. U.S. petroleum inventories declined by 6.2 million barrels in the week ended Dec. 10, according to data from the

American Petroleum Institute

. Total U.S. crude inventories, at about 280 million barrels, are 4.4% below historical averages, and are nearing the extreme lows last seen in 1996. And that downward trend is expected to continue into the first quarter.

On the demand side, the

Energy Information Administration

is forecasting demand growth of about 1.8%, or 1.4 million barrels per day in 2000, mainly driven by slow and steady growth in demand from Asia. Contrast that with 1998, when demand grew by just under half a million barrels.

Eventually, both

OPEC

and non-OPEC producers will have to increase production to meet the growing demand and to offset an expected inventory deficit.

And that feeds an improving spending picture. Independents such as

Apache

(APA) - Get Report

,

Nuevo

(NEV) - Get Report

and

Louis Dreyfus

(LD) - Get Report

have already announced huge increases in capital expenditures after about three months of $25-a-barrel oil.

The bigger players are ratcheting up spending as well, though more gradually: Oil majors and state-owned companies will boost spending on exploration and production by 5.7% next year, according to a

Lehman Brothers

survey of 320 oil companies released last week.

But in the oil and gas industry, there is always room for surprises, such as

Texaco's

(TX) - Get Report

announcement Friday that it will increase its 2000 budget by more than 20%, to $4.7 billion, from an estimated $3.9 billion this year. If other oil majors and state-owned companies follow suit and surprise to the upside, it's the bottom lines of the service companies that will benefit.