DLJ: Oilfield service firms' stock values up; earnings remain low

Oilfield service company stocks outperformed the market during the first quarter, but earnings were relatively dull by comparison, say analysts at Donaldson, Lufkin and Jenrette.

Oilfield service company stocks outperformed the market during the first quarter, but earnings were relatively dull by comparison, say analysts at Donaldson, Lufkin and Jenrette Inc., New York.

Service stocks enjoyed a major rebound as commodity prices surged and company earnings showed signs of recovery. The weakening of technology stocks also played a part, as investors shifted their assets to more traditional companies.

The group �set a new benchmark� for outperformance during the first quarter, said DLJ, with stock values for land drillers up 65%. Deepwater drillers bypassed land drillers as their stocks gained 51% due to increased spending by the majors and an increased number of contracts for idle rigs. Stock prices for service-manufacturing companies and shallow-water drillers climbed 50% and 42%, respectively, while the stocks of offshore construction and seismic companies were up 35.2% and 34%. The large-capitalization, diversified group was up only 27%, however, dragged down by the poor performance of Halliburton�s non-oilfield businesses.

Despite the gains in stock prices, DLJ analysts Arvind S. Sanger and Stuart T. Kagel say they anticipate only modest gains in service company earnings for the first quarter vs. fourth quarter 1999. Only a few companies�mostly a few "leveraged" names, says DLJ�enjoyed significant benefits from strong US prices and strong activity and prices in Canada. These stocks are trading at �significant trading multiples� to other companies with greater international leverage, which are likely to be only one to two quarters behind in their earnings upside.

DLJ also pointed out that drilling activity remained weak in the US and elsewhere during the first quarter. Non-US rig counts declined modestly compared with fourth quarter 1999. Only the Canadian rig count enjoyed a slight seasonal upswing.

Year-to-year revenue and net income comparisons will likely remain negative in this sector for the first quarter. The analysts expect the large-cap group will show a 1% sequential decline in revenues and flat net income. Mid and small-cap companies will see a decline of 3.6% but a net income improvement of 7.3%, helped by cost reductions and consolidation during the downturn. Sanger and Kagel said equipment contractors should see sequential revenues improve by 7.7% but have flat net income, as international and deepwater contracts rolling to lower dayrates offset newbuild start-ups and North America improvements.

Both analysts say they�ll keep their "outperform" rating for the group, however, adding that revenue and net income numbers �will be positive, on a sequential basis, for most companies in our universe.� Among large-caps, both Baker Hughes Inc. and Schlumberger �show good sequential comparisons,� as will several mid and small-cap service companies and drillers.

The non-US and deepwater markets will offer investors the most upside, as increased budgets for both the majors and national oil companies flow into these sectors. Signs of a �meaningful uptick� in demand should appear in the second quarter and second half of this year.

�We also believe the best buys are not necessarily those companies with the best upside potential in the first quarter...but rather those stocks that will see the next recovery in the coming months,� the analysts said. Those names include large-cap service companies such as Baker Hughes as well as mid and small-cap companies or the deepwater and land drillers, such as Cooper Cameron Corp. and Diamond Offshore Drilling Inc.

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