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Dim Near-Term Outlook for Oilfield Services Industry

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The Zacks Oil and Gas- Oilfield Services industry comprises companies that primarily engage in providing support services to upstream players. These companies help in manufacturing, repairing, maintaining wells and drilling equipment, leasing of drilling rigs, seismic testing, transport and directional solutions, among other services. 

Let’s take a look at the industry’s three major themes:

  • Oil prices have an immense influence on the performance of oilfield services industry. Higher commodity prices boost the spending levels of upstream players, as they can derive more value for their products. With oil drilling becoming profitable on commodity price uptick, oilfield services players can, in turn, charge more for their services. Conversely, if oil prices tumble, the oilfield services industry is likely to be one of the first ones to feel the pinch. Notably, oil prices have been dipping into bear-market territory of late, after touching multi-year highs of more than $76 a barrel in early October. Since then, the commodity has plunged more than 33% on fears of oversupply and economic headwinds, which may in turn dampen demand. All eyes are now on the OPEC meeting, to be held on Dec 6, wherein the countries involved may introduce a set of production cuts, which might stabilize prices, raising hopes for oil field services companies. However, increasing pressure from Trump to avoid production curb may push prices lower, which may spell further trouble for the oilfield services industry. 
     
  • Oilfield services suffered the most during the oil slump, as the top line of the companies belonging to this industry dwindled much quicker than upstream players, courtesy of producers limiting their purchases and even canceling the majority of service contracts. However, it’s not just about the commodity prices. Despite crude being on an upward trajectory for most part of 2018 and shale producers reaping profits, the picture for the oilfield services players has not been rosy. The industry has struggled with forced efficiencies, reduced day rates and diminishing backlogs, which affected earnings and revenues of most companies. Notably, during the crude downturn, the upstream players invested in cost-cutting measures to keep 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 softened revenues for oilfield services companies.
     
  • As mentioned earlier, performance of the oilfield services industry took a beating owing to shrinking capital investments by energy explorers and cost-controlling initiatives, which compel contractors to settle for lower day rates, translating into discouraging results for the service firms. On a further discouraging note, oilfield service providers are reeling under heavy debt burden and lower cash flows. In fact, according to recent reports by Moody’s rating agency, it is likely to become difficult for these companies to repay their long-term debts, unless they witness a surge in cash flows. The staggering debt levels will certainly weigh on their near-term credit quality. Needless to say, while the large-cap firms are more poised to regain their credit strength, the smaller rivals are likely to go through a rougher patch. Another thing worth noticing here is the fact that while the oilfield services companies focusing on onshore development may get some relief from the boost in drilling activities (especially from the U.S. shale plays), the offshore service providers will be the worst sufferers.


Zacks Rank Indicates Tepid Prospects

The Zacks Oil and Gas - Drilling Industry is a 37-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #157, which places it in the bottom 39% 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 tepid near-term prospects. 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.

Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimate for the current year has declined by almost 18%.  

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and valuation picture.

Industry Lags Sector & S&P 500

The Zacks Oil and Gas – Oilfield Services Industry has significantly underperformed the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.

The industry has declined 24.4% over this period versus the S&P 500’s growth of 1.7% and broader sector’s fall of 5.2%.

One-Year Price Performance



Industry’s Current Valuation  

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing oil and gas drilling stocks, the industry is currently trading at 6.1X compared with the S&P 500’s 10.22X and sector’s 5.12X.

Over the past five years, the industry has traded as high as 11.07X, as low as 6.10X and at the median of 7.80X, as depicted in the chart below.

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

 

 

 


Bottom Line

The oilfield services industry has been hit hard by contraction of activities and revenues, canceled or renegotiated contracts at lower day rates, along with massive layoffs. Even with the spike in oil prices, the improving landscape is not likely to filter down to oilfield services soon, as the upstream players are benefiting from discounted dayrates.

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 upstream players looking 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.

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. Expansion or addition of new market offerings, adoption of superior technologies, innovation of business processes, as well as integration of value chain offerings, acquisitions and profitable collaborations, among other strategic strides, will enable the companies to perform well in the current market scenario.

With near-term prospects of the industry looking dim, below are two stocks that we recommend investors to steer clear of.

Core Laboratories N.V.. (CLB - Free Report) : Amsterdam, Netherlands-based C&J Services currently has a Zacks Rank #4 (Sell). The Zacks Consensus Estimate for current-year EPS has moved 9.1% south over the past 60 days.

Price and Consensus: CLB



 

Mammoth Energy Services, Inc. (TUSK - Free Report) : Oklahoma -based Mammoth Energy carries a Zacks Rank of 4. The consensus estimate for current-year EPS has moved 8.3% south over the past 60 days.

Price and Consensus: TUSK



However, there are a few stocks in the Zacks Oil and Gas-Oilfield Services industry, which investors can add given their solid growth prospects.

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

Ranger Energy Services, Inc. (RNGR - Free Report) : Houston-based Ranger Energy sports a Zacks Rank #1.  The Zacks Consensus Estimate for current-year EPS has moved 47.3% north over the past 60 days.

Price and Consensus: RNGR



Unit Corporation (UNT - Free Report) : Oklahoma -based Unit Corporation carries a Zacks Rank #1.The Zacks Consensus Estimate for current-year EPS has moved 11.9% north over the past 60 days.

Price and Consensus: UNT



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