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Oilfield Services & Equipment
INITIATION
Activity, Intensity & the Super Cycle
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We initiated coverage of the Oilfield Services & Equipment Sector with an
Overweight position. We believe world commodity fundamentals, customer
cash flows and continued low reinvestment rates are supportive and that the
sector has years of growth ahead of it. Commodity correction and stock
trajectory has been startling to say the least, but we are convinced it has
created opportunities to buy shares.
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More powerful growth opportunities come from combination of rig count and
rising service “intensity”. Non-North America (non-NAM) land, deepwater
equipment and services and subsea hardware offer 15-20% per year top-line
growth potential for several years, in our view. Illustrations of service
intensity gains: (1) we calculate a 7% CAGR in the cost of drilling a well (exinflation)
for non-NAM land from 2004 to 2007; (2) $/subsea tree ordered
grew at a 46% CAGR from 2005 to 2007; and (3), prospectively, deepwater
rig count will double by 2012 (drilling by far the most service intensive wells)
and deepwater rig order pace is up 50% yr./yr. thus far in 2008.
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New building blocks are key to upside surprise potential, and therefore stock
performance, for our diversified services names. BHI, SII and WFT have
relatively new ability to (1) bundle services, (2) take advantage of rising
service intensity; and/or (3) effectively sell in several more non-NAM markets.
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Still see slower growth, volatility and capacity risk in North America. Natural
gas production growth points to ample storage for winter and softer pricing.
Credit Suisse E&P analyst Jon Wolff’s $8.25/Mcf 2009 outlook and softer
funding market underpin our assumption of a flat rig count and modest price
declines as of the second half of 2009 in North America (NAM).
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Ratings. We launched coverage with Outperform ratings on Baker Hughes,
FMC Technologies, National Oilwell Varco, Smith and Weatherford; an
Underperform rating on BJ Services; and Neutral ratings on Schlumberger,
Halliburton, Cameron, Exterran, Global Industries, and Oceaneering.
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Geographic-based P/E valuation for diversified services; DCF for
infrastructure. On estimated 2009 earnings for diversified services names,
we apply a 12 P/E multiple point discount to NAM exposure versus non-NAM.
And we introduce DCF valuation for infrastructure names to capture the
value of deepwater and subsea exposure.
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We selectively fight headwinds. We think WFT’s IPM risk, is overstated. But
we remain on the sidelines on EXH and GLBL, despite longer-term growth
potential (for both primarily related to exposure to global gas).
Executive Summary
We initiated coverage of the U.S.-based Oilfield Services & Equipment sector with an
Overweight position. We strongly believe this spending upcycle will continue. Consistent
with Credit Suisse Integrated Oils team, we believe oil company efforts to address
production declines through the drill bit should continue into at least the next decade. The
challenge for non-OPEC firms appears particularly acute given declining reserve
replacement. We also view pricing and demand growth for global natural gas as
sustainable and supportive of more drilling activity and infrastructure investment as well.
And even at $100 oil, the International Oil Companies (IOCs) continue to generate vast
amounts of cash—it seems unlikely that cash availability is the relevant constraint on
these firms spending a lot more at the drill bit.
As has been the case throughout this current upcycle, it is simply easier to have stronger
conviction regarding multi-year growth prospects for international land and offshore
(particularly deepwater) upstream spending versus in North America (NAM). It is in these
provinces IOCs and National Oil Companies (NOCs) are pursuing growth; this is true
particularly in offshore, which has seen two-thirds of recent industry discoveries. The rigs
are coming, with a lot of fanfare in the deepwater but also on land, in our view. And we
look for continuation of two favorable trends that span our coverage: (1) “service intensity”
(rising cost per well excluding price) and (2) product/service bundling.
Rising service intensity is the result of both the need for more services to tackle more
challenging reservoirs and the availability of more and better technology to do so;
directional drilling with Rotary Steerable Tools; more formation evaluation/reservoir
characterization tests (e.g. electromagnetic, pressure testing, acoustic testing); and more
sophisticated completions technologies are all examples. Our proprietary analysis pointed
to a 7% CAGR from 2004 to 2007 in non-NAM land in service intensity (interestingly, the
same exercise for NAM yielded only a 3% CAGR, although this makes sense if we
consider, for example, the relatively “low tech” approach to much of the Barnett.
The bundling phenomenon is interesting as well. Approaches vary, but oil companies are
outsourcing some, or in the case of Integrated Project Management, much, of the
arrangement, coordination and/or well planning responsibility. Human resource shortages
at oil companies are part of the rationale, as are attempts at volume discounting, but
relevant too are oil service company pitches that having many of the well construction
services provided by one company can raise efficiency.
The combination of more rigs, service intensity and bundling creates a landscape
that allows for 15-20% average revenue growth for several years (1) outside of NAM,
(2) in deepwater and (3) in subsea, in our view.
In NAM, the oil industry has clearly established it is growing natural gas production
onshore. It isn’t hard to create a scenario where gas prices fall and E&Ps struggle to fund
resulting cash flow shortfalls to sustain drill bit programs—particularly given the current
sensitivity in credit and equity markets. Consistent with Credit Suisse E&P team’s view of
natural gas prices of $8.25 per thousand cubic feet (mcf) in 2009, we are modeling activity
growth in the U.S. through the second quarter of 2009 and then a rig plateau that
pressures pricing and yields 5%-ish lower revenues by the end of 2009 versus mid-year.
Stock Selection
The recent sell-off in energy leaves us with a favorable bias for most of our names over a
medium-term horizon. However, we consider the following in picking our favorites:
New building blocks. Our preferred diversified services names—BHI, SII, and WFT—are in
the process of transforming themselves into more diversified companies on both a product
line and a geographic basis. We look for revenue and margin potential as they reap the
benefits of these investments, either through more bundled sales or higher-asset utilization
in new regions. NOV is in this position to some degree as well, as it extends its drill string
coverage through its Grant Prideco acquisition.
Tailwinds vs. Headwinds. The management teams and companies have done the obvious
heavy lifting to position themselves for the upcycle and do not have too great a near-term
overhang, either from company-specific issues or NAM exposure.
Attractive valuation. We measure this relative to the peer groups, respective geographic
orientation and our multi-year cash flow generation outlooks.
Table of contents
Executive Summary 5
Investment Thesis Summaries 9
Outperform 9
Neutral 9
Underperform 10
Macro (Commodity Outlook) 11
Oil 11
U.S. Natural Gas 13
Diversified Services Overview 15
Summary 15
State of the Sector 15
Outlook 24
Use of Cash 31
Valuation 34
Risks 36
Infrastructure Sector Overview 39
Summary 39
Rig Equipment 40
State of the Sector 40
Outlook 41
Offshore Production Infrastructure 42
State of the Sector(s) 42
Outlook 47
Use of Cash 49
Valuation 52
Risks 52
Appendix 1: Rig Count Forecast 54
Appendix 2: Market Share Estimates 55
Appendix 3: Oilfield Glossary 56
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