Waiting for Investors to Patch the Leaks in Oil-Service Stocks

With earnings recovery for oil companies falling short of expectations, investors have gotten skittish.
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It seemed as if oil-service providers had struck a gusher.

Oil prices have more than doubled since February. Some oil producers are already increasing their exploration budgets, giving business to service companies. And the cost-cutting measures oil-service firms undertook over the past year are set to fatten their bottom lines. Those factors combined to push the sector's leading stocks as much as 75% higher for the year through early September.

But over the past two weeks, the stocks have sputtered as analysts began cutting third- and fourth-quarter earnings estimates. It turns out that the earnings recovery for these companies is still a way off, and investors, still reeling from the industry's recession, are skittish. As a result, oil-service stocks have fallen by as much as 20% over the past two weeks.

And now, instead of buying for the long haul, investors are jumping in and out of these stocks, buying on good news and selling at the first whiff of bad. And it's unlikely that many will do anything different until they see year 2000 earnings estimates rise.

For now, estimates are getting trimmed like limbs on a Douglas fir on Christmas Eve.

Halliburton

(HAL) - Get Report

warned late Monday that it expects to earn between 11 cents and 13 cents a share for the third quarter, well below the consensus estimate of 19 cents. Its shares fell 5% Monday and were sliding sharply Tuesday as well, off 13% around midday.

Meanwhile, analysts have cut estimates on companies from No. 4 service provider

Weatherford International

(WFT) - Get Report

to tiny seismic-equipment supplier

Input/Output

(IO) - Get Report

in recent days.

Sinking Feeling
Oil-service shares stage a sharp selloff.

Source: BigCharts

Just a month ago,

Baker Hughes

(BHI)

was trading in the mid-30s, and analysts expected it to earn 6 cents a share in the third quarter, according to

First Call/Thomson Financial

. Analysts have since trimmed that estimate to 3 cents. Baker's stock followed, falling into the upper 20s.

"People are selling over near-term concerns about earnings," says Bill Herbert, co-head of oil-service research at

Simmons

in Houston.

Given this, Jim Wicklund, managing director of energy research at

Dain Rauscher Wessels

, says trading the stocks, rather than holding them, makes the most sense for now. When the

Philadelphia Stock Exchange

oil service index dips below the low 80s, investors should buy, and they should sell when the OSX approaches 90, Wicklund says. The index closed Monday at 74.20. But go long by early spring to take advantage of the expected upswing, Wicklund recommends.

"We may start seeing positive earnings revisions

for 2000 maybe as early as the fourth quarter but maybe in the first quarter," Herbert says.

Exactly when 2000 estimates rise depends on when the major oil companies, the predominant explorers and producers, refocus on exploring rather than merging. Last year, U.S. majors and independents spent more than $84 billion on exploration and production; this year that total is expected to drop to $67 billion. For 2000, however, some analysts are estimating overall spending will increase 17% to 20%. More than 70% of the oil companies responding to

Salomon Smith Barney's

midsummer spending survey planned to increase 2000 budgets.

Some investors have used the group's recent weakness for opportunistic buying. One such buyer is Steve Schwartz, the research director at

Circle T

, a New York-based hedge fund that is bullish on the group. The selloff a week ago shows that "people are failing to see the bigger picture," Schwartz says. And although he declines to name the companies his firm was nibbling at in recent days, his fund is long

R&B Falcon

(FLC) - Get Report

,

Nabors Industries

(NBR) - Get Report

and

Grey Wolf

(GW)

.

What investors like Schwartz see is an expected increase in demand on the back of improving Asian economies, and eventually, expanding overseas exploration. Brazil's

Petrobras

in late September announced a major deep-water discovery in the country's Santos Basin, which should spur further exploration. Algeria's state-owned oil company,

Sonatrach

, said last week it expects to sign a $1.2 billion deal as early as next year with a consortium led by

Anadarko

(APC) - Get Report

to develop the country's second-largest oil field. And Iran's announcement last week that it discovered a 26 billion-barrel field, reportedly equal to about 80% of total U.S. reserves and its largest find in 30 years, will surely have oil companies lining up in Tehran.

But those developments will take time -- hence the confusion. One institutional salesman who requested anonymity says of the current state of the oil-service group, "My clients don't know whether to buy or sell." For the next few months, it may make sense for them to do both.