Another Quarter Of Discontent For Energy Services?

By Stephen D. Simpson, CFA | December 17, 2012 AAA

It looks like the energy services sector isn't going to deliver any sort of Christmas miracle this year. While I don't believe investors were expecting especially strong results for the calendar fourth quarter, early guidance is suggested that this is going to be a disappointing end to what has been a pretty dismal year.

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Rigs Keep Easing
The data from Baker Hughes (NYSE:BHI) on global rig counts for November was not especially strong. The United States rig count fell more than 1% from October and the November 2012 count was about 10% lower than the 2011 figure, as producers continue to cut back in the face in the face of low natural gas prices.

Not helping matters, Baker Hughes also reported relatively lackluster international counts as well. While there is still growth (0.6% month on month for November, and nearly 7% over last year), the pace is slowing. That's a problem, as international business has been helping major service companies like Schlumberger (NYSE:SLB), Baker Hughes and Halliburton (NYSE:HAL) offset some of the North American slowdown.

SEE: Oil And Gas Industry Primer

And Here Comes the Guidance ...
Basic Energy Services (NYSE:BAS) has had a thoroughly rotten year, with shares down about 40% over the past 12 months on that slowdown in North American activity. Well, it just got a little worse. Management recently announced that utilization rates have continued to decline in the fourth quarter, with serving rig utilization down to 62% in November (from 72% in October) and drilling rig utilization down to 76 from 85%. Not surprisingly, this is having a negative impact on revenue, and management doubled its forecast for the sequential quarterly revenue decline (from a range of 5 to 7% to a range of 12 to 14%).

While that's certainly a negative for Basic Energy shareholders, and not an especially encouraging sign for other well servicing companies like Key Energy (NYSE:KEG), the worse news came on Friday from Schlumberger.

The giant energy services company announced before the open on Friday that drilling activity in North America was slower than expected and that international business (particularly in Europe, Russia and Africa) has tailed off more than expected. As a result, the company lowered its EPS guidance by 5 cents to 7 cents a share - suggesting that the company is going to report a 3 to 5% year-on-year decline in earnings per share for the fourth quarter.

SEE: Can Earnings Guidance Accurately Predict The Future?

How Much Further to Bottom?
This year has highlighted a key problem when it comes to energy investing - not only are these companies cyclical, but the length and depth of the cycles are very hard to forecast. All of that said, there are reasons for investors to be cautiously optimistic that the end is in sight.

Bad 2012 results have been fueled in part by a glut of pressure pumping equipment, but that should start to ease up in the first half of 2013. Although large companies like Baker Hughes, Schlumberger and Halliburton have been increasingly parking equipment due to a slack demand, the equipment in the field undergoes pretty harsh wear and tear, and supply and demand should start coming into better balance in another quarter or two. Of course, low natural gas prices are a sizable part of the problem and it's going to be tough for this recovery to take hold if energy prices drop further (a credible risk if the fiscal cliff chews into U.S. economic growth in 2013).

The Bottom Line
Valuations are starting to look pretty good on a long-term basis, but that was true last quarter, and the quarter before as well. Consequently, while I can see why aggressive investors might want to start taking positions now banking on the eventual recovery, they shouldn't do so unless they are prepared for a 10% or more downside risk (these stocks tend to always go higher/lower than expected at the peaks and troughs of the cycle). In the meantime, investors may also want to consider equipment vendors like National Oilwell Varco (NYSE:NOV) and FMC Technologies (NYSE:FTI) as solid plays on the next offshore drilling/production cycle.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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