What to Glean From Oil Service Providers’ Strong Earnings

Surprised at the strong results? Don't be.

   

What to Glean From Oil Service Providers’ Strong Earnings

Although it wasn’t supposed to be this way, first-quarter earnings for oil service companies have rolled in far better than expected. Low natural gas prices and relatively high crude oil prices were supposed to adversely impact oil service providers like Halliburton Company (NYSE:HAL) and Schlumberger (NYSE:SLB). Sometimes though, like now, there’s a whole lot more to the story.

So Why Haven’t They Hit a Wall Yet?

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The premise is simple enough — natural gas is all the rage, and crude oil is so very yesterday. You absolutely have to invest in the former, and the latter is off limits because ‘big oil’ is lost in so many ways (not the least of which is struggling oil prices). Ergo, don’t touch Schlumberger, Halliburton, National-Oilwell Varco (NYSE:NOV) or any other oil well service and equipment provider with a 10-foot pole.

And for the most part, investors have steered clear. HAL shares have been nearly cut in half since last July’s peak. At $71.70, SLB is well under its 2011 peak price of $95.

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Considering the market’s well up for the same time frame, the weakness implies these oil names have not and will not thrive until the natural gas glut is over.

A funny thing happened on the road to disaster, though. These companies didn’t get shipwrecked, even if their stocks have been stranded for months. Halliburton, for instance, posted per-share profits of 89 cents for Q1, topping estimates of 85 cents, and easily topping earnings of 61 cents for the same quarter a year earlier. Schlumberger nailed it too, bringing home 98 cents per share versus expectations of 97 cents. Last year’s Q1 profit of 71 cents per share was left in the dust.

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We don’t have National-Oilwell Varco’s fiscal first-quarter results yet, but it topped estimates for Q4 when it reported back in early February.

A fluke? Hardly. It was Varco’s 11th earnings “beat” in the past 16 quarters. Schlumberger has been on a decisive growth streak since mid-2009. Halliburton has been growing the bottom line like crazy, too.

But what about cheap natural gas getting in the way? That’s where investors might want to stop drinking the media’s “obvious” Kool-Aid and start checking out the fine print — there’s a reason these oil service names aren’t drowning.

Reality Check

Details matter. Not that this information wasn’t out there before Q1’s numbers were posted, but their importance seems to just now be hitting home.

  • They might be categorized as “oil well service providers,” but companies like Halliburton and Schlumberger are just as involved in natural gas too. And yes, when gas was all the rage — and stunningly profitable — back in 2008, these guys were clamoring to get in.
  • Cheap natural gas might have helped grow the industry, but there’s such a thing as too cheap. With natural gas at multi-decade record lows (again), energy companies are starting to shutter gas operations because the fossil fuel can’t be mined and sold profitably. Big oil doesn’t see natural gas prices rising anytime soon, either.
  • Yes, Halliburton and Schlumberger are two of the natural gas players that are shifting away from low-margin and no-margin gas and putting the focus back on high-margin liquid fuel (crude oil)… particularly deepwater drilling. This isn’t a hypothetical possibility — this is actually happening now. The bulk of the expenses for the shift, however, won’t be booked until Q2 … the current quarter.
  • For the service providers and equipment players, anyway, crude oil doesn’t have to be at sky-high prices to grow the bottom line. In fact, stable (read: “sustainable’”) prices seem to be the key to growth longevity. It’s a supply/demand balance the natural gas industry still hasn’t found.
  • Last but not least, while both the oil and natural gas industries seem to be stabilizing, even if gas is stabilizing at lousy prices, the biggest stumbling block now is one nobody was even thinking about a year ago. There’s a growing lack of guar. What’s guar? It’s a plant — a legume, technically — that’s used to help extract crude oil as well as natural gas. The problem is, oil drilling requires more guar than natural gas mining does. So, as the industry shifts the focus back to more profitable crude oil, the guar industry can’t keep up with revived demand. It’s not just some silly whining, either.

Moral of the Story

The lesson learned? There are probably several, but there’s one overarching takeaway: Income growth here isn’t just a function of rising oil prices. The service and equipment providers might be part of the energy sector, but they’re the least sensitive to energy prices. That’s not to say earnings have been perfectly predictable for the last few years, but they’ve been very consistent compared to most other industries. That hasn’t changed as of last quarter.

Also, considering the shift away from gas and back to oil has happened with no fanfare (from them) whatsoever, they’re also the most flexible group in the energy industry. It looks like the market is finally starting to understand that.

Oh, and just for the record, Halliburton says it’s the only service name that has enough guar to go the distance. That, paired with the fact that it’s trading at a pretty cheap P/E of 10.8, makes it the top-shelf name within the oil well equipment and service group.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2012/04/q1-earnings-oil-service-providers-hal-slb-nov/.

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