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FTSE 350: Oil services positioned for cautious project sanctions

Prospects for the oil services companies in 2017 are very much reliant on geography - with US shale recovery to the fore
January 26, 2017

Logic suggests that the slow rebound in the oil price, cemented by Opec’s aforementioned agreement to curtail daily global output, has put oil services companies on surer footing. Because of its reliance on capital expenditure budgets, the sector has arguably had a worse time than its clients. Consequently, the rebound in the share prices of the FTSE 350 oil equipment and services companies in the past year should also be seen in a wider context.

Hunting (HTG), whose shares were one of the best performers among the industry’s established operators last year, started 2016 “without a single path to guide” it, in the words of chief executive Dennis Proctor. In effect, a path emerged in the form of a nascent US shale recovery; this regional exposure also benefited John Wood (WG) and bodes well for the first half of this year, during which time analysts at SEB expect tight oil producers to add 30 rigs a week.

The timing of Hunting’s $71m equity placing in October could not have been better, with improving market confidence that the oil market would start to rebalance in 2017, and that projects may once again have a chance of being commissioned. The group’s focus on manufacturing and well construction puts it in a capital-intensive portion of the sector, although equipment pricing has held up relative to areas such as staffing.

But, while busier US divisions have recently proved the differentiator, oil services remain dogged by overcapacity, which was a legacy of the energy boom years when major producers generated little in the way of free cash flow. The current market position of Amec Foster Wheeler (AMFW) is a case in point. The group’s heady expansion in the past decade meant it was caught short when energy and commodity markets contracted, forcing a costly wholesale restructuring of the business. A pivot towards clean energy, which now makes up around a third of the order book, may be a sensible long-term strategic move, but one that could be slowed by governmental cuts to renewable subsidies.

Nevertheless, with writedowns booked and oil now back above $50 a barrel, oil services executives will be feeling more optimistic than at any point in the past three years. The trajectory of project approvals can only really go one way.

Price (p) Market value (£m)PE Yield (%)1-year change (%)Last IC view
Amec Foster Wheeler4631,8057.34.718.1Buy, 451p, 1 Nov 2016
Hunting6201,014NA0.4147.6Hold, 469p, 5 Sep 2016
Petrofac9213,1868.35.530.3Buy, 835p, 29 Sep 2016
Wood Group (John)8743,33015.22.751.7Hold, 723p, 16 Aug 2016

Favourites: We have some confidence that Petrofac (PFC) is in a particularly sweet spot in the sector. Its exposure to gas projects in the Middle East – as demonstrated by this month’s award of a $600m (£485m) gas contract in Oman – coupled with the conclusion of a disastrous project for Total, means the group just needs to progress through its large order backlog to boost earnings. Its lower exposure to the most capital-intensive elements of the supply chain also bodes well for cash flows.

Outsiders: Although our long-term advice to buy Amec’s shares was rocked by October’s trading update, we think the sell-off was largely sparked by the spectre of a rights issue. The shares’ somewhat derisory forward multiple should not therefore come as much surprise, although it is hard to see how sentiment could wane much further.