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How Coronavirus-Hit Energy Sector Shapes Oilfield Services Firms

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

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

Coronavirus-induced demand destruction and a weak oil price scenario have triggered a deterioration in the energy market environment. The price of U.S. crude, which has been in the bearish territory, fell below $12 a barrel recently, while Brent crude recently dropped to less than $15 – its lowest level since 1999. As oil prices are not enough to support profitable exploration and production operations, most upstream operators are scrambling to cut costs and stay afloat. The demand for oilfield services is likely to remain low, as customers are curtailing operations. Moreover, the global crude oil supply glut has put pressure on producers, in turn ailing oilfield services players.

Per Baker Hughes Company (BKR - Free Report) data, the count of oil and gas drilling rigs has been declining week after week. This reflects conservative capital spending by domestic explorers, bringing down the number of contracts for oilfield services. For instance, TechnipFMC plc (FTI - Free Report) — a leading manufacturer and supplier of products, services and fully integrated technology solutions for the energy industry — witnessed more than 66% year-over-year decline in inbound orders in first-quarter 2020. To navigate through the current market uncertainty, majority of oilfield service players are slashing their 2020 capital expenditure budget.

Oilfield service providers are reeling under a heavy debt burden and declining cash flows, which are weighing on their near-term credit quality. This is making survival difficult for the concerned companies as the oilfield service market in North America is highly competitive. While the large-cap entities are more poised to regain their credit strength, the smaller players are likely to go through a rough patch, especially given the current market situation. Economic recovery from the coronavirus pandemic and supply-cut response from OPEC+ to counter the market situation are expected to support the crude price environment in the future. This will likely bring back contracts for oilfield services firms.

Zacks Industry Rank Indicates Cloudy Prospects

The Zacks Oil and Gas – Field Services is a 29-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #152, which places it in the bottom 40% 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.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. 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 estimates for the current year have declined almost 69.7%.  

Despite the industry’s bleak near-term prospects, we will present a few stocks that investors can retain, given their solid prospects. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Beats Sector, Lags S&P 500

The Zacks Oil and Gas - Field Services industry has outperformed the broader Zacks Oil - Energy sector but lagged the Zacks S&P 500 composite over the past year.

The industry has declined 37.7% in the past year compared with the broader sector’s fall of 44.5%. The S&P 500 has lost 3.7% in the same time frame.

One-Year Price Performance

Industry’s Current Valuation

Since oil and gas companies 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 not just equity into account 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 EV/EBITDA, the industry is currently trading at 3.77X compared with the S&P 500’s 10.36X and the sector’s 3.76X.

Over the past five years, the industry has traded as high as 13.39X, as low as 3.20X, with a median of 8.65X.

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

Bottom Line

The North American market is currently under pressure due to coronavirus-induced lockdowns, dwindling rig counts and tightened capital budget by upstream companies. However, domestic and international markets are expected to improve once the travel bans are retracted and economies get into recovery mode.

Since early studies of the coronavirus drug trial have shown some success, the social distancing rules are expected be lifted in the near future, which will likely lead to higher energy consumption and crude prices. This will, in turn, increase the count of drilling rigs and bump up final investment decisions for clients’ projects. Till things get to or near normal, it might be prudent for investors to maintain caution by either keeping on the sidelines for a while or holding on to these five fundamentally-sound Zacks Rank #3 (Hold) stocks. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Halliburton Company (HAL - Free Report) : Houston, TX-based Halliburton Company is one of the largest oilfield service providers in the world that offers a variety of equipment, maintenance plus engineering and construction services to the energy, industrial and government sectors. This company is likely to see earnings growth of 10.4% in the next five years.

Price and Consensus: HAL

Linde plc (LIN - Free Report) : Based in Guildford, U.K., the company is an industrial gas and engineering service provider. The company has an expected earnings growth rate of 8.9% for first-quarter 2020.

Price and Consensus: LIN

Schlumberger Limited (SLB - Free Report) : Houston, TX-based Schlumberger helps upstream energy players locate oil and gas, as well as drill and evaluate hydrocarbon wells. The company is likely to see earnings growth of 6.6% in the next five years.

Price and Consensus: SLB

TechnipFMC plc (FTI - Free Report) : Headquartered in London, U.K., it is a leading manufacturer and supplier of products, services and fully-integrated technology solutions for the energy industry. The company has an expected earnings growth rate of 23% for 2020.

Price and Consensus: FTI

Baker Hughes Company (BKR - Free Report) : Based in Houston, TX, this is one of the world’s largest oilfield service providers that sell technologies and services to different clients. The company is likely to see earnings growth of 8% in the next five years.

Price and Consensus: BKR

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