Hunting cash does not justify rating

Oil-industry services provider Hunting pulled off a masterstroke last summer with the sale of Gibson Energy, its subsidiary that services Canada's tar-sands oil industry, to private equity interests. Hunting got a top-of-the-cycle price of £617m for a not-terribly-profitable business just before the collapse of the oil price made extracting oil from tar-sands a lot less attractive. So now it is sitting on net cash of around £400m. It has earmarked this for acquisitions to bolster its remaining activities, which are focused on constructing oil and gas wells. Our concern, however, is what the fortuitous influx of all this money will do to Hunting's share price rating.

Hunting shares trade on a PE ratio of 19 times 2009's forecast earnings (see table). Yet shares in other London-listed oil services companies look a lot cheaper. For example, Petrofac's rating is just seven times forecast earnings. Even shares in Amec, which were the most highly rated of oil-services companies, are only rated at 12 times. One simple explanation is that deducting Hunting's cash from its stock market value - and adjusting the earnings side of the equation, too - leaves the shares rated at a more modest multiple of around seven times 2009's forecast earnings. But that calculation works for the other oil services companies, too. Knock Petrofac's net cash of £332m off its market cap and its 2009 forward PE ratio drops to six. Similarly, deducting Amec's £750m net cash drops its earnings multiple to around seven times as well.

Yet, arguably, Petrofac and Amec are both considerably better-placed than Hunting to weather the downturn in the oil-services sector. All will suffer from slowing activity, and City analysts now assume a 10-12 per cent drop in spending on hydrocarbon exploration and production globally in 2009, with particularly steep falls of around 20 per cent in the US and Russia. But, even as low oil and gas prices, cash-conserving major oil companies and bankrupt junior players shred the outlook for capital spending over the next couple of years, Petrofac has been demonstrating the resilience of an order book focused on state-owned oil companies operating in the low-cost Middle East environment. And, while Amec's oil-services businesses don't look particularly immune to a slowdown, it has other competencies, such as nuclear engineering, to cushion the blow.

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The new-look Hunting can take no such comfort from resilient customers or ancillary lines. Quite the opposite, in fact. The overwhelming bulk of its remaining business is split roughly equally between supplying well services in the US and the UK. The problem is the projected steep decline in US capital spending which looks to be panning out so far, with drilling rigs employed already at the lowest level seen since mid-2005. The UK market, focused on the North Sea, is not looking much prettier. Too many junior companies, which account for much of the North-Sea development, are in distress, and Hunting itself has recently been guiding City analysts to lower their estimates of demand for its North Sea well services in the coming year, which is likely to prompt them to cut their profits forecasts.

Hunting's results for 2008 are due in a couple of weeks, at which point shareholders will want to hear exactly where that cash pile is destined to be used. And while the cash is a boon, one drawback is that it has to be redeployed to avoid a large tax bill on the Gibson disposal. The current environment should be throwing up opportunities for Hunting's experienced and canny management to consider. That said, in the current environment the chances of buying a peach only to discover that it's a lemon are higher than usual. So successful acquisition execution is far from certain.