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4 Oil & Gas Equipment Stocks Countering Industry Headwinds

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The energy spectrum has witnessed massive demand destruction all around the globe due to the coronavirus pandemic since early-2020. Although the challenges in the path of demand growth have subsided due to vaccine rollouts, the North American upstream market is still witnessing uncertainties, further marring the Zacks Oil and Gas- Mechanical and Equipment industry’s outlook.

Nevertheless, with travel ban removals and people returning to work, energy suppliers' and oilfield equipment players' prospects have improved. USA Compression Partners, LP (USAC - Free Report) , NOW Inc. (DNOW - Free Report) , Oil States International, Inc. (OIS - Free Report) and Exterran Corporation (EXTN - Free Report) are among the frontrunners in the industry that are trying to transcend coronavirus blues.

About the Industry

The Zacks Oil and Gas - Mechanical and Equipment industry comprises companies that provide necessary oilfield equipment — production machinery, pumps, valves and several other drilling appliances like rig components — to exploration and production companies. These help upstream players in the extraction of oil and natural gas from fields, both onshore and offshore. Hence, the wellbeing of oilfield equipment businesses is positively correlated to expenditures from upstream companies. These companies receive deals from integrated firms, and independent as well as national oil and gas companies. Oilfield equipment providers also design, manufacture, engineer and install products used in the treatment and processing of crude oil, natural gas, and others. Their products also comprise gadgets and instruments used in gas compression packages, and water treatment works.

4 Trends Defining Oilfield Equipment Industry's Future

Uncertain Pricing Scenario: Although crude oil price has significantly increased in the past few months, it is very much reliant on OPEC+ members’ compliance with production curb deals, making the gain volatile and unsustainable. Last year, the dented crude price on account of the coronavirus pandemic forced most upstream companies to cut their capital spending budget. Cautious explorers and producers are still not boosting spending to pre-pandemic levels, which in turn is keeping demand low for oilfield equipment service providers. The situation is not expected to dramatically improve to pre-pandemic levels until the end of 2021 or early 2022.

Tepid Upstream Investments: Exploration and production companies are now constrained by a reduction in borrowing capacity and an increase in the cost of capital. Also, explorers are facing constant pressure from their investors for higher returns instead of production growth. These headwinds are keeping investments from upstream players in the land market of North America under check. Even though a resumption of upstream activities in the U.S. shale plays has been witnessed in the past few months, upstream firms are playing defensively. They are now prioritizing sensitive capital allocation and value increase for shareholders over rapid production rise. Therefore, the oilfield equipment industry outlook appears gloomy.

Bleak Subsea Opportunities & Tough Competition: Oil and gas producers are currently focusing keenly on onshore drilling, wherein associated costs are much lower than that of offshore expenses. Off the coast projects are highly capital intensive, which is why project leaders are somewhat delaying investment decisions as they rather concentrate on shale plays. Hence, even though the overall energy market is currently witnessing some improvements, the subsea equipment market demand outlook is far from being encouraging. Thus, capital equipment bookings for the offshore market are yet to witness any substantial turnaround. With scaled down upstream investment, the existing oilfield equipment companies are fighting hard for available funds. As a result, intensified competition has left limited room for the companies to charge premium prices for the services being offered.

Building Resiliency: To navigate through the tough market conditions, oilfield equipment providers have resorted to balance sheet strengthening and sensitive capital expenditure. This is likely to help the companies survive the market downturns while boosting resiliency. Oilfield equipment providers are now depending on capital efficiency to increase cash retaining and value generation from their operations, which will enable them to thrive in the long term. Their focus is on reducing costs and expenses from operations, will likely enable the companies to boost profits.

Zacks Industry Rank Indicates Dim Prospects

The Zacks Oil and Gas - Mechanical and Equipment is a 11-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #218, which places it in the bottom 13% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bearish near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

Before we present a few stocks that you may want to buy or retain, as these can navigate through the uncertainties, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Underperforms Sector and S&P 500

The Zacks Oil and Gas - Mechanical and Equipment industry has underperformed the broader Zacks Oil - Energy sector and Zacks S&P 500 composite over the past year.

The industry has increased 16.5% in the past year compared with the broader sector’s rise of 29.4%. The S&P 500 has risen 37.7% in the same time frame.

One-Year Price Performance

Industry's Current Valuation

Since oilfield equipment providers are debt laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of non-cash expenses.

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), the industry is currently trading at 11.97X, lower than the S&P 500’s 18.10X. However, it is higher than the sector’s trailing-12-month EV/EBITDA of 5.40X.

Over the past five years, the industry has traded as high as 48.04X, as low as 2.48X, and with a median of 12.35X.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

4 Oilfield Equipment Stocks to Keep a Close Eye on

Considering the downbeat industry scenario, it might be prudent for investors to maintain caution by either keeping on the sidelines for a while or holding on to these three fundamentally-sound Zacks Rank #3 (Hold) stocks. We have also dicussed a stock with a Zacks Rank #2 (Buy).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

NOW Inc.: Headquartered in Houston, TX, NOW is a leading provider of downstream energy and industrial products to different energy companies in North America as well as international markets. Its services include providing supply chain and materials management solutions to clients. Despite the current market volatility, the company generated $173 million of free cash flow in the trailing 12-month period, which further shows its strength in operations. The stock has increased 18.3% in the past six months, buoyed by strong operations, and there is more room for growth. With its growing focus on providing products in accordance with the gas utility industry's specifications, its revenue generation in the upcoming quarters is expected to witness a significant uptick.

The Zacks Rank #2 player has seen three upward estimate revisions and no downward movement for its 2021 bottom line in the past 60 days. Earnings per share are expected to grow 100% year over year in 2021. It beat earnings estimates thrice in the trailing four quarters and missed on the other occasion, delivering an earnings surprise of 28.7%, on average.

Price and Consensus: DNOW

USA Compression Partners: This firm is one of the largest independent natural gas compression services providers across the United States in terms of fleet horsepower. The partnership is also involved in engineering, design, operation, service and repair of compressor units. USA Compression Partners earns revenues based on the overall horsepower usage of natural gas transported rather than the price. In fact, the firm is largely insulated to fluctuations in commodity prices. The partnership’s diligence in maintaining a balance between capital spending and cash flow stability is a major growth driver.

In the past six months, the stock has gained 16%. It is expected to grow further on the back of increasing average horsepower utilization and focus on midstream compression. The Zacks Consensus EPS estimate for the current year points to a 94% year-over-year improvement. This Zacks Rank #3 company beat earnings estimates twice in the trailing four quarters and missed on the other two occasions.

Price and Consensus: USAC

Oil States International: This Houston, TX-based company provides highly engineered capital equipment for oil and gas industry players. This Zacks Rank #3 company’s manufacturing and service facilities are strategically located around the world. To navigate through the current market uncertainty due to the coronavirus pandemic, it has been focusing strongly on cost-reduction initiatives. The stock has increased 11.3% in the past six months and is expected to further grow on the back of strength in the Offshore/Manufactured Products business.

Improved performance of short-cycle products can position the company for massive gain in the coming quarters. In the second quarter, Offshore/Manufactured Products generated $4.8 million in operating income, sequentially improving from $1.1 million. Its bottom line is expected to grow 33.3% year over year in 2021. This company beat earnings estimates in the last four quarters, with an average of 17.1%.

Price and Consensus: OIS

Exterran Corporation: Based in Houston, TX, Exterran provides gas processing and treating facilities for natural gas processing companies. Also, it has commendable experience with high-spec operations in delivering floating production storage and offloading solutions. The Exterran Water Solutions business scored a massive contract last quarter, further underlining its strength in accelerating the transition to a sustainable energy business. The stock has jumped 36.3% in the past three months. We expect its ability to reduce operating costs for upstream clients to position it for further growth in the coming days.

Its focus on improving commercial activities and strong backlog will help the company for massive gains in the long haul. In fact, over the next two years, the company anticipates adjusted EBITDA to increase at a minimum compounded rate of 15%. This Zacks Rank #3 company beat earnings estimates thrice in the trailing four quarters and missed once.

Price and Consensus: EXTN