While the crude pricing strength has enabled the exploration and production companies to successfully resurface from the downturn, the oilfield services industry unfortunately, still remains in the doldrums.
Oilfield services companies are primarily engaged in providing support services to upstream players. They help manufacturing, repairing and maintenance of wells and drilling equipment, leasing of drilling rigs, and processing of seismic data, among other services.
During the oil slump, the production companies resorted to cost containment efforts, slashing their capex and delaying drilling projects. These in turn, caused a decline in demand for oilfield services to a huge extent. In order to survive, the upstream players invested in cost-cutting measures to keep the drilling activities economical in the low-price environment. Investments in technological advancements involving pad drilling and rig mobility have led to efficiency gains for producers but have softened revenues for oilfield services companies.
With the gradual uptick in crude prices to over $70 of late, shale producers have successfully shifted from survival to thrive mode. However, the oilfield services players are still struggling under forced efficiencies, reduced day rates and diminishing backlogs, affecting the earnings and revenues for most companies.
Industry Underperforms on Shareholder Returns
Looking at shareholder returns over the past year, it is quite evident that the crude price recovery has not been able to provide the much-needed impetus to oilfield services industry. The said industry had been worst hit due to the crude downslide as the top line of companies belonging to this industry dwindled much quicker than other upstream players, thanks to producers limiting their purchases and even canceling most service contracts.
Performance of oilfield services industry took a beating amid shrinking capital investments by energy explorers and the cost-controlling initiatives, which primarily imply compelling the contractors to settle for lower day rates, translating into discouraging results for the service firms.
The Zacks Oil and Gas- Oilfield Services Industry, a 36-stock group within the broader Zacks Oil and Energy Sector, has underperformed both the S&P 500 and its own sector over the past year. While the stocks in this industry have collectively declined 6.5%, the Zacks S&P 500 Composite and the Zacks Oil and Energy Sector have rallied 13.8% and 15.6%, respectively.
One-Year Price Performance
While most regions, especially offshore, continue to struggle despite the oil price recover, other basins like the Permian, have thrived. As such, performance was slightly better off for the oilfield service providers operating in Permian than the other regions.
Stocks Trading Cheap for a Reason
One might get a good sense of the industry’s relative valuation, looking at its enterprise value-to EBITDA ratio (EV/EBITDA), the most appropriate multiple for valuing the capital intensive oilfield services stocks, given their significant debt levels and high depreciation plus amortization expenses.
With the stocks within the oilfield services industry having underperformed over the past year, the industry's valuation picture seems attractive at first glance.
The industry currently has a trailing 12-month EV/EBITDA ratio of 6.57X, trading at its lowest level over the past year, as the chart below that compares the industry's one-year EV/EBITDA valuation picture relative to the Zacks Energy sector. Over the past year, the industry has traded as high as 10.83X, with a one-year median of 7.89X.
Enterprise Value/EBITDA (TTM)
Comparing the group’s EV/EBITDA ratio with that of its broader sector shows that the industry is trading at a discount. The Zacks Oil and Energy Sector’s trailing 12-month EV/EBITDA ratio of 6.66X and one-year median level of 6.65X for the same period are below the Zacks Oilfield Services Industry’s respective ratios. Investors should note that the industry has historically traded at a premium to its sector.
Enterprise Value/EBITDA (TTM)
However, the space looks inexpensive when compared with the broader market as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.69X and the median level over the past year is 11.41X.
Though the industry appears cheap, its low valuation multiples likely reflect underlying problems with fundamentals. While the companies might look too lucrative to be ignored based on the industry's hefty discount to market at large, one must however, exercise much caution here pertaining to the context of diving day rates, margin compression, rife competition and reduced utilizations.
Underperformance May Persist on Bleak Earnings Outlook
With the rebounding crude prices —indicative of a major influential factor to drive the oilfield industry — one might expect the services industry to pick up the pace. However, the industry is not expected to revive too soon amid oversupply, which will keep the dayrates in check.
As it is, what really matters to investors is whether this group has potential to perform better than the broader market in the quarters ahead. While the valuation analysis shows that there is plenty of room to run, one should not really consider the current price levels as good entry points unless there are convincing reasons to predict a rebound in the near term.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences its stock performance.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for it as well as the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019 while the light blue line represents the same for 2018.
Price and Consensus: Zacks Oil and Gas- Oilfield Services Industry
Please note that the industry’s $1.44 EPS estimate for 2018 is not the actual bottom-up dollar estimate for every company within the Zacks International E&P industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the industry’s earnings per share for the current year but how this estimate has evolved recently.
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Current Fiscal Year EPS Estimate Revisions
While the consensus earnings estimate for the Zacks Oil and Gas — Oilfield Services industry of $1.44 per share shows a year-over-year deterioration, the trend in earnings estimate revisions is not favorable either. The consensus EPS estimate for the current fiscal year has been revised 5.8% downward since Apr 30, 2018. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings potential.
Zacks Industry Rank Indicates Tepid Prospects
The group’s Zacks Industry Rank is basically the average of the Zacks Rank of all-member stocks, reflecting underperformance in the near term.
The Zacks Oilfield Services Industry currently carries a Zacks Industry Rank #205, placing it at the bottom 20% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank has deteriorated considerably over the past three weeks. It has consistently remained in the bottom half over the past several months.
In fact, the basis of this bearish view can also be established by the revenues of the oilfield service companies, which have sharply declined in three consecutive years ending 2016.
While in 2017, the revenues witnessed a slight increase of around 4.2%, the same has not been proportionate to the tremendous improvement in the crude prices.
Another important indication of a lukewarm future prospect is the deterioration in the group’s free cash flow, a key metric for evaluating oil and gas drilling stocks. It’s quite clear that the companies are not generating enough cash to pay off debt along with funding capex and dividend payments.
Oilfield services industry has been hit hard by contraction of activities and revenues, canceled or renegotiated contracts at lower day rates and massive layoffs. And even with the spike in oil prices, the improving landscape is not likely to filter down to the oilfield services too early. That said, 2018 is much likely to remain a challenging year for the oilfield services industry as the upstream players are gaining advantage from the discounted dayrates in spite of soaring demand and tightening labor market.
However, the oversupplied state of oil services sector is likely to fade away in the coming years, if not in the immediate future. With the labor market already getting tighter and the upstream players seeking to rev up production amid higher oil prices, the bargaining power in contract negotiation is likely to shift to oilfield service companies, which will be well-positioned to earn higher fees for their services provided.
While the oilfield services industry is likely to rise from the ashes in the coming years, it should presently focus on adapting to the current market scenario successfully. Expansion or addition of new market offerings, adoption of superior technologies and innovation of business processes, integration of value chain offerings, acquisitions and profitable collaborations among other strategic strides will help enable the companies perform well in the current market scenario.
With the near-term prospects of the industry looking dim, below are two stocks that we could recommend investors to steer clear of.
Core Laboratories N.V. (CLB - Free Report) : Amsterdam, Netherlands-based Core Labs carries a Zacks Rank #5 (Strong Sell). The Zacks Consensus Estimate for current-year EPS has been revised 5.8% downward over the past 60 days.
Price and Consensus: CLB
C&J Energy Services, Inc. ( (CJ - Free Report) : Texas-based C&J Services has a Zacks Rank of 5. The consensus estimate for current-year EPS has been moved 15.2% south over the past 60 days.
Price and Consensus: CJ
However, there are a few stocks in the Zacks Oil and Gas-Oilfield Services industry, which investors can acquire on the back of their solid growth prospects. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
SEACOR Holdings, Inc. (CKH - Free Report) : Headquartered in Florida, SEACOR sports a Zacks Rank #1. The consensus mark for current-year EPS has been raised 32.4% over the past 60 days.
Price and Consensus : CKH
Mammoth Energy Services, Inc. (TUSK - Free Report) : Based in Oklahoma, Mammoth Energy sports a Zacks Rank of 1. The Zacks Consensus Estimate for current-year EPS has been moved 23.2% north over the past 60 days.
Price and Conensus: TUSK
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