Energy Industry Report: Energy Perspectives - October 2012

Third-quarter earnings have since been announced, with not so surprising results, as all three struggled during the quarter versus 3Q 2011, highlighting depressed natural gas prices, lower rig counts, and challenges in North America operations as major contributors. All have expressed the possibility of further weakness and margin contraction into Q4 for North America given existing trends with an expectation that the next few quarters could be erratic. Although North America has been identified as the weak spot for the companies, Schlumberger and Halliburton are more protected from swings in earnings due to their more diverse, internationally-based revenue mix. Notably, Schlumberger performed positively during Q3 in its international business, but declines in revenues and margins in North America largely offset the international gains. Schlumberger still outperformed its peers on a firm-wide basis, however.

North America (“NAM”) segment difficulties stem from depressed natural gas prices, a lower rig count, significant pricing pressures, and curtailed E&P spending. Although exploration and production companies (E&Ps) scrambled to transition gas rigs to liquids rigs, the net change in rigs was still negative in North America with land rig count down 4% year-over-year. Cost inflation and pricing pressures in hydraulic fracturing further added to lower NAM margins given the influx (read: oversupply) of hydraulic horsepower across oil basins. Moreover, the volatile year in natural gas prices led more than a few independent E&Ps to burn through their spending budgets earlier in the year than expected. Although this occurrence is planned for, insiders indicate that 2012 has been worse than usual and that Q4 will be especially challenging. Changing industry fundamentals and further exposure to underserved international markets and offshore operations will be the major challenges and growth opportunities for the major oilfield service and equipment companies moving forward.

The PHLX Oil Service Index, a price-weighted index of 15 mid- to large-cap oilfield service and equipment companies, indicates current valuations of 7.1x EBITDA down from 8.6x only one year ago. Comparatively, Baker Hughes currently trades at 5.8x EBITDA and its stock price has dropped 20% over the last year; Halliburton trades at 5.7x EBITDA and its stock price has increased 2% since last year; and the leader Schlumberger trades at 9.4x EBITDA and its stock price has risen 7.5% from one year ago. Ultimately, it’s clear that investors are paying up during tough economic times for companies that offer revenue resiliency and international diversity combined with solid fundamentals, focused product offerings, and well-elaborated strategic initiatives.