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Oilfield services companies might not see value improve until 2021, analysts say

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Oilfield services companies might not see value improve until 2021, analysts say

Oilfield services companies face another challenging year in 2020 languishing at the bottom of the investment pool before valuations improve and recovery gets underway in 2021, Raymond James analysts said.

Although oilfield services stocks are trading at unreasonably low levels, recovery is not likely until 2021, the analysts said Jan. 6.

"Given that we see supply rationalizing and demand bottomed, we view this as a transition year and as the time to be invested in the space," analyst Praveen Narra said.

From a supply perspective, efficiency gains led to continued productivity in 2019 despite a 25% reduction in the rig count driven by capital spending cuts by producers, the analysts said.

Efficiency gains are slowing into 2020, and while the analysts expect a 10% reduction in U.S. exploration and production budgets as capital discipline continues, rig activity and frack demand are expected to begin climbing out of the trough established in the fourth quarter of 2019.

The analysts see U.S. rig activity up 6.1% and frack demand up 8.1% from the fourth-quarter 2019 lows. They also see a modest 5% increase in the international rig count.

The U.S. rig count is forecast to climb by about 45 rigs in 2020, with 66% of the new rigs destined for the Permian Basin, Narra said.

Oilfield services companies have also restricted capital spending, which has limited reinvestment rates and will continue to reduce capital equipment, the analysts said. Of the oilfield services companies covered by Raymond James, capital spending was down nearly 20% year over year, Narra said, and the market remains oversupplied even as reduced spending led to equipment scrapping and less competition.

The ratio of supply to demand pressured pricing for oilfield services companies through 2019. Additional supply tightening in 2020 and an eventual call on equipment for both offshore and U.S. land activity implies current asset valuations and returns are unsustainable, the analyst said.

Given that expectations and valuations are expected to have bottomed, Raymond James is bullish on oilfield services, particularly on companies doing completions work, Narra said.

The anticipation of higher returns led Raymond James to revise its outlook on Texas-based ProPetro Holding Corp. from outperform to strong buy and Georgia-based RPC, Inc. from market perform to outperform. It downgraded Oklahoma-based driller Unit Corp. from market perform to underperform due to its high financial leverage and insufficient free cash flow.

"While drilling activity will also improve, we do not see a supply response as forming as these assets are significantly lower on the capital intensity side. While rising activity and a much more consolidated market should keep day rates from entering a death spiral for most regions, there is still downward pressure on rates," Narra said.

Raymond James' top picks include Houston-based oilfield services major Halliburton Co. for large companies and Houston-based Helix Energy Solutions Group Inc. and ProPetro for smaller companies.