Dril-Quip in Neutral Lane

We are maintaining our Neutral recommendation on Dril-Quip (DRQ - Analyst Report), following the better-than-expected third quarter results, partially offset by the challenging macro environment.

Headquartered in Houston, Texas Dril-Quip manufactures highly engineered offshore drilling and production equipment for deepwater severe-service applications and harsh environmental conditions. The company’s products are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world.

In the third quarter, Dril-Quip posted earnings of 58 cents per share, a penny ahead of the Zacks Consensus Estimate but deteriorated 15.9% from the year-ago profit level of 69 cents. The company registered total quarterly revenue of $155.0 million, up 10.6% from the year-ago level of $140.1 million, supported by higher sales of subsea equipments and growth in service revenues, partially offset by a decrease in offshore rig equipment revenues.

Dril-Quip guided fourth-quarter earnings per share in the range of 53 cents to 63 cents. With an expected increase in deepwater activity over the next few months coupled with a robust backlog, we expect Drill-Quip to post strong profit growth in the upcoming quarter, beyond its guidance range.

We also believe that Dril-Quip has strong leverage to continued strength in global deepwater drilling markets, especially in South America and the Asia-Pacific region. Given the operators’ long-term outlook on these projects, deepwater drilling and other related services will remain relatively stable through the usual fluctuations in commodity prices.

However, as inherent in the energy sector, Dril-Quip remains exposed to the volatile oil and gas fundamentals. Moreover, the company derives a major portion of its operating income from the U.S. Gulf of Mexico (GoM), through sales of subsea wellheads, mudline suspension systems and subsea production trees. We still remain concerned about the aftermath of the deepwater drilling moratorium in the region.

We also apprehend that rising material and labor costs (Dril-Quip is a vertically integrated manufacturer) will likely continue to weigh down on margins in the near to medium term.

As such, the company has exhibited restricted growth in the past few quarters and we expect this trend to continue. Dril-Quip, which faces competition from peers such as FMC Technologies (FTI - Analyst Report), retains a Zacks #3 Rank that translates into a Hold rating for the short term.

Read the full analyst report on DRQ

Read the full analyst report on FTI