Some energy market observers and executives hold that oilfield services will see a boom parallel to the Internet boom of the mid 1990s, if oil prices remain at current levels or climb higher. The primary reasons for their upbeat view include the expectation of a strong long-term growth in emerging markets, which amid a surge in the demand and despite the gains in the energy output will threaten to cause an imbalance in the energy market. The tightening of the market conditions and the rising cost of oil exploration and extraction bode well for the long-term growth of the oilfield services market. This sanguine outlook is a boon for the sector’s companies, most of which have solid balance sheets, pay dividends, and boast attractive valuation characteristics.
The optimistic prospects for the oilfield services companies are based on expectations of strong oil and natural gas prices in the next few years. Elevated oil prices are stimulating oil and natural gas companies to seek new energy supplies, even at increasing costs. According to The Economist, over the past 10 years, “the oil industry’s spending on exploration and production has increased fourfold, while oil production is up by only 12%.” Growth of major oilfield service companies has averaged about 10% annually. Robust growth will likely remain the norm, on average, even though some slowing down in activity may be observed in North America, where oilfield activities – including plunging natural gas rig counts and stagnating oil rig counts – are taking a breather after several years of robust growth.
International markets are currently driving the sector’s expansion. A recent survey of more than 300 oil and gas companies by Barclays has found that oilfield activity will boost oil exploration and production spending to a record-high $644 billion in 2013. This will represent an increase of about 7% from the previous year and will be driven mainly by international growth. The pause in boosts to North American spending on oilfield services will likely end once oil prices pick up as the global economies recover, boosting the demand for energy.
What does this mean for the sector’s companies? It means that the short-term profitability of the major diversified North American oilfield services companies – referred to as the Big Four and including Schlumberger
), Baker Hughes
), and Weatherford International
) – will not be as stellar as over the past several years. This is the result of the easing in oil prices relative to the year-ago levels, expensive migration from natural gas to more-profitable oil drilling, and rising input costs (e.g. guar gum shortage that caused a surge in prices). In the near-term, the market players with greater international exposure, such as Schlumberger, will fare better than the ones more focused on the North American oil industry. This is so because international rig counts are rising and margins for activity outside North America are expanding.
Still, the long-term outlook foresees a robust EPS expansion. For example, Schlumberger’s EPS is expected to grow, on average, by 16.2% annually for the next five years. Baker Hughes and Halliburton will see their EPS expand, on average, by 11.5% and 17.7% per year, respectively, for the next half-decade. In the same period, the EPS of Core Laboratories, a provider of reservoir management and production enhancement services, is forecast to grow at a CAGR of 18.3% annually. Ensco Plc
), which provides offshore contract drilling services, will see an exceptionally robust EPS expansion, averaging 27% per year for the next half-decade.
Given that most major oilfield services companies are dividend payers with low payout ratios, rising profitability bodes well for their dividend growth in the future. The table below shows the main characteristics of the stocks and dividends paid by several key oilfield services players.
Most of these companies represent sound long-term investments. For example, Halliburton and Baker Hughes are attractive on valuation, boasting below-market and below-industry multiples. These two diversified oilfield services companies and Schlumberger have price-to-earnings, price-to-book, price-to-sales, and price-to-cash flow below historical metrics. Subsea 7
and Ensco also boast attractive valuation. Core Laboratories
) is a good dividend growth stock.
The expected increase in the demand for oilfield services in the future will make this sector attractive for growth-oriented investors. In the meantime, there is a possibility to take advantage of attractive valuations on some of the sector’s players ahead of possible, growth-driven expansion in earnings multiples. While dividend yields offered by most of the sector’s companies are relatively low, dividends of the oilfield service providers have a good chance to see accelerated growth in the future.