Thursday, 26 February 2015

Discounted Oil Service Company Stocks

Oil 5

Basic Trading Concepts Defined

With oil prices in a long slump, the oil field service industry is feeling the pinch. These are the companies that provide equipment and expertise for services like drilling, hauling, inspection, engineering, and surveying. As exploration and production slows, the oil field service industry is faced with fewer new deposits and projects coming online. Halliburton, one of the largest companies in this industry, has already made a move to acquire another giant, Baker Hughes. Investors can expect more merger and acquisition activity if oil prices continue to slump. In this article, we will look at buying discounted stocks of the oil service companies with the best chance of emerging from the slump.


The $10 Billion Plus Club

Market capitalization is a poor number to hang your investing strategy on, but it is a convenient way to sort out the biggest players in an industry. This is important as size matters when it comes to surviving hard times in oil. The biggest players in the industry are working in markets all over the world with different profit points. The chances are extremely low that all the clients in a large oil service firm's book would shut down production at the same time. In theory, the market cap of a company also includes all the market information about that company plus the market’s confidence in that information. There are six oil companies in the world with over $10 billion in market capitalization.

Schlumberger Limited (SLB)   Market Cap 109.90

Halliburton Company (HAL)   Market Cap 33.33

National Oilwell Varco, Inc. (NOV)   Market cap 28.22

Baker Hughes Incorporated (BHI)  Market Cap 24.26

FMC Technologies, Inc. (FTI)   Market Cap 10.95

Access Midstream Partners, L.P. (ACMP)   Market Cap 10.34

Note that Halliburton is slated to acquire Baker Hughes but the two are still listed independently. Once all regulatory hurdles are cleared for their merger, there will only be 5 companies that clear $10 billion mark. More interestingly, these figures were pulled in December 2014. Since then, FMC Technologies has dropped to sub $10 billion and all of these companies have seen some negative change. These giants do differ in which service offerings they focus on and which markets they pull most of their revenue from, but all will likely survive the current slump--and do so with balance sheets that will allow them to snap up business throughout the recovery.


The Issues With Market Cap

Investing over the $10 billion market cap may be a safe bet on size, but you may miss opportunities great mid-sized companies that are more focused on providing services to the oil field sector. Smaller, less diversified companies are hit harder when the price of oil slumps. However, their valuations also recover more quickly once oil prices rise again. With a market cap of $8.8 billion, Weatherford (WFT) does not make the top six list, but investors shouldn't ignore this company entirely. It has been divesting non-core assets (some to Warren Buffett’s Berkshire) and becoming much more focused. Weatherford could become an acquisition target again as its smaller size and weakening share price attracts the biggest firms.

Investors who only look at the largest market caps can also miss smaller international players with growth potential. For example, China Oilfield Services (COSL) is majority owned by the Chinese government and positioned in markets that other oil service companies cannot access. That diversification may be important if prices don’t recover to the point where shale oil and gas are profitable for an extended period of time. Whether it is a good idea to invest in a state-owned enterprise is a completely different question.

Finally, when looking for investment opportunities in oil services, look outside the industry at general engineering and constructions firms as well. For example, heavy construction company Fluor (FLR) does not come to mind in oil services. However, this company competes effectively in the resource extraction sector, including in mining and oil. Also consider big companies with small interests in oil and gas services. General Electric’s (GE) oil and gas division is a small slice of the company’s overall revenue, but helped drive its growth in 2014. Such companies tend to be the first to pull out of oil services if oil drop continually as they can focus on other industries. This makes them poor choices if you are looking to get oil services exposure.


U.S. Oil Service

The total market value of the U.S.-listed companies classified as oil and gas equipment and services is right around $300 billion, of which the ten biggest companies account for around $247 billion. The most obvious insight is that there is a lot of consolidation at the top already. While oil prices remain low, consolidation will continue either by acquisition or by attrition. This concentration of market value at the top speaks to the need of oil service companies to grow their service offerings to contract to the state-run oil companies and the global oil companies like Exxon (XOM). While one region - for example, U.S. shale gas and oil - might slow down at a specific price point, other clients in other regions of the globe are still profitable and still drilling.

Bottom Line

There is a lot to be said for size in hard times. All the companies in the $10 billion plus market cap group are likely to survive the oil price slump. They may do it by combining like Halliburton and Baker Hughes are, but they will continue to operate in some form. Many smaller companies in the oil services industry could fail as margins shrink, but some of the sub $10 billion companies may actually be better bets because of their focus outside North America and on deposits with a bit more profit margin than shale and oil sands deposits. Either way, the challenging market created by the oil price slump is starting to open up opportunities to buy oil service stock at a steep discount.

Reference: Andrew Beattie

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