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We are reiterating our long-term Neutral recommendation on Dril-Quip Inc. (DRQ - Analyst Report). The stock retains a Zacks #3 Rank – which translates into a Hold rating – for the short term. 

In the recently reported second quarter, Dril-Quip recorded earnings of 55 cents per share, failing to match our expectation. The company registered total revenue of $137.0 million, down 3.5% from the year-ago level of $142.0 million. The underperformance was mainly due to the decrease in sales of offshore rig equipment.

As of June 30, 2011, Dril-Quip had a backlog of $727 million compared with $538 million at the end of the same period last year. Although orders remain strong, higher engineering expenses and testing of equipment prior to manufacture in a post-Macondo environment is affecting the company’s ability to turn backlog into revenues.

Management expects third quarter earnings to range between 50 cents and 60 cents per share, essentially flat with the recently reported quarter. Given expectations for increased deepwater activity over the near term and a record backlog, we expect the company to outpace its profit growth guidance.

The planned investment of the Brazilian state-run energy giant Petrobras in the country’s offshore market over the next five years will likely prove beneficial for Dril-Quip, which is well positioned to take advantage of the projects based on its strong and long-standing relationship with Petrobras. As such, in the near future, Drill-Quip remains well suited for Petrobras' planned 20 newbuilds and continued general secular growth.

However, with a major part of Dril-Quip’s company-wide operating income being generated from the U.S. Gulf of Mexico (GoM) – through sales of subsea wellheads, mudline suspension systems and subsea production trees – we remain concerned about the aftermath of the deepwater drilling moratorium in the region.

Further, a recent change in the sales mix has resulted in margin deterioration for Drill-Quip, as more pipes and connectors are being shipped relative to its higher margin deepwater subsea wellheads.

Therefore, as of now, we don't see any obvious catalyst in its business that would significantly push the stock price higher. Consequently, we see Dril-Quip shares performing in line with the broader market.

Dril-Quip faces tough competition from competitors like Matrix Service Co. (MTRX - Snapshot Report) and CE Franklin Ltd. .

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