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A different way into energy

Christopher Boxall casts an expert eye over the global energy equipment & services sector
February 1, 2013

The providers of key equipment and services to the energy sector aren't household names like the oil majors, but the Gulf of Mexico oil spill in April 2010, which brought one of the world's largest public corporations close to bankruptcy, highlighted their importance to the industry.

The UK market has its share of attractive energy services businesses, the largest of which, Petrofac (PFC:LSE), Amec (AMEC:LSE) and John Wood Group (WG/:LSE), have proved attractive investments over the past few years. However, despite the obvious qualities of these and the handful of other UK-listed groups, they are but bit players compared with the market leaders, the largest of whose market value is nearly three times that of the combined value of the entire UK oil services sector. In order to be able to fully assess the world of energy equipment and services it's therefore essential to venture further afield.

 

SEISMIC/GEOPHYSICAL

Long before the drilling and extraction begins, it's essential to gain an understanding of the resource potential, which is where the seismic and geophysical groups come into play. The largest of these is WesternGeco, a division of Schlumberger (SLB:NYSE), the world’s leading oilfield services company. Founded in 1926, Schlumberger employs over 100,000 people and has a current market capitalisation of over $105bn. It’s hard to operate in the energy services arena without bumping into SLB whose rating (2013 PER 16.7 times) reflects its rock-solid finances and leading position in the industry.

Other large geophysical/seismic specialists include Compagnie Generale de Geophysique Veritas (GA:PAR) and Fugro (FUR:AEX), which sold its seismic division to the former for €1.2bn in September 2012. This isn't an area for income seekers but, somewhat unusually for the sector, Fugro offers an encouraging 3.4 per cent yield at the current share price.

The Oslo stock exchange is dominated by oil equipment and services groups, including two large seismic players in Petroleum Geo-Services (PGS:OSL) and TGS Nopec Geophysical (TGS:OSL). It's interesting to compare the contrasting approaches and structures of these two groups, which also applies to other players in the sector. Asset-rich PGS's large fleet of seismic vessels benefits handsomely when times are good and its vessels are fully utilised, but has to absorb high fixed costs when the market slows, as occurred in 2009 and 2010. TGS, by contrast, charters its vessels and has delivered consistently over the past five years. While shares in PGS have had a good run of late in the currently supportive market, they still remain far off the highs reached in 2008. In recognition of its more consistent returns the share price of TGS moves ever skyward.

 

 

Seismic small caps to watch

SEB Enskilda Equity Research recently reported that it expected growth in seismic spending of 19 per cent in 2012 and 18 per cent in 2013. A couple of small caps that could benefit from this highly supportive environment are Alternative Investment Market (Aim)-traded Thalassa Holdings (THAL:Aim) and Oslo-listed marine seismic operator Dolphin Group (DOLP:OSL).

Thalassa is a small Aim-traded marine seismic operator which recently announced news of a sizeable contract offshore Ecuador. The seismic market continues to look in excellent shape and this small group - currently valued close to its net tangible book value (which includes a good lump of cash) and trading at just seven times December 2013 full-year estimates - looks compelling value.

Dolphin Group operates a fleet of new-generation, high-capacity seismic vessels and has been growing rapidly over the past few years. It is well spread globally, with a presence in Norway, the UK, Singapore, Brazil and Houston. Trading at just under six times full-year 2013 estimates with a supportive shareholder base the shares also look attractive at current levels.

 

The UK's John Wood Group has proved an attractive investment.

 

THE DRILLERS: ONSHORE

The drilling groups are split into two groups: onshore and offshore. The activities of the former are centred on North America, which has experienced a huge growth in activity as a result of the successful exploitation of shale reserves through hydraulic fracturing, or 'fracking' as it is known.

Large US onshore contract drilling and pressure pumping groups such as Helmerich & Payne (HP:NYQ), Nabors Industries (NBR:NYQ), Patterson-UTI Energy (PTEN:NSQ) and Canada-based Precision Drilling (PD:TOR) invested huge amounts in new equipment to support the shale boom only to see the usual laws of demand and supply kick in, pushing US natural gas prices lower and the producers curtailing the drillers' gas-related activities.

As equipment became under-utilised and returns declined, the share prices of many North American onshore drillers and pressure pumpers tumbled, with the producers subsequently directing equipment from gas to oil drilling activity. As the valuations of many drilling groups fell below their tangible net asset value and equity markets in general stabilised, bargain hunters have come in and the share prices of the drilling groups have staged a modest recovery. While many of the large onshore drilling groups such as Nabors Industries continue to trade below their net tangible asset value there is a strong likelihood of material impairments, so potential investors should not get fixated on this perceived value. Even so, some believe the North American onshore drillers could represent an interesting recovery story in 2013.

The alternative approach

Rather than invest in the service providers directly investors can also adopt a different approach and gain exposure to the providers of key materials to the sector. Two such providers are Carbo Ceramics (CRR:NYQ), a supplier of ceramic proppant, and Silica Holdings (SLCA:NYQ), a producer of sand proppants. Proppants are a vital element in the fracking process, enhancing the flow of gas, and CRR and SLCA would therefore be major beneficiaries of increased levels of drilling activity in North America.

 

 

THE DRILLERS: OFFSHORE

The giants of the drilling world are the operators of the huge offshore deep-water rigs which currently cost upwards of $1bn apiece. Up until the 2010 Gulf oil spill, Transocean (RIG:NYQ), which is dual-listed in New York and Zurich (RIGN:VTX), was far and above the world's largest offshore drilling group by market capitalisation. The sinking of the group's Deepwater Horizon drilling rig and subsequent spill saw it lose its crown to Norway's Seadrill (SDRL:OSL), a newer creation of Norwegian shipping magnate John Fredriksen.

But an improved operating performance and the presence of activist investor Carl Icahn on its share register has recently boosted Transocean's share price, pushing the valuation to the top of the pile again (current market cap $20bn). The leading groups generally operate a mix of shallow water 'jackup' rigs and larger floating rigs or 'floaters', which operate in both mid and deep water. Transocean continues to run the largest overall fleet with a total of 91 rigs with other large fleet operators London-headquartered Ensco (ESV:NYQ) and Swiss registered Noble Corp (NE:NYQ); notwithstanding their geographic registrations the shares of all these groups are listed in New York. Seadrill's high value is a reflection of its modern fleet (average age four years) as oil companies are willing to pay a premium to use the most modern rigs and latest equipment. Income watchers may be attracted by Seadrill's near-9 per cent yield or that of another Oslo listed drilling group Fred Olsen Energy (FOE: OSL), which operates an 'aged' fleet of 11 rigs (average age 24 years) and whose shares yield nearly 8 per cent. With the oil price supportive and the most modern ultra-deep-water rigs currently achieving rates of over $600,000 per day, investors are attracted to the sector, foreseeing the potential for big payouts in the future as the cash starts to roll in - let's hope they don't get carried away like the onshore drillers.

 

 

Alternative deep-water play

An alternative, potentially lower-risk way of gaining exposure to the offshore space is to invest in providers of offshore accommodation. This doesn't have the excitement of frontier drilling, but there is also less chance of a catastrophic event like Macondo to spoil things. Oslo-listed Prosafe (PRS: OSL) has a market capitalisation of NOK12.27 (£1.4bn) and is the largest provider of accommodation rigs to the offshore drilling sector. The group currently owns and operates 11 semi-submersible accommodation rigs and has two under construction. The group has delivered excellent results over the past few years, with operating margins of over 40 per cent supporting attractive cash generation and growing dividends. The current yield is approximately 6 per cent.

 

Oslo listed Prosafe is the largest provider of accommodation rigs to the offshore drilling sector.

 

EQUIPMENT PROVIDERS

The largest provider of key equipment to the oil patch (onshore and offshore) is US-listed National Oilwell Varco (NOV:NYQ). Much like Schlumberger, if you are in the business of providing equipment to the oil and gas sector it's hard to avoid NOV, whose market dominance is illustrated by its ticker-derived nickname 'No Other Vendor'. Despite its large size, market dominance and robust balance sheet, the shares trade at a seemingly modest 11.3 times forecast estimates for 2013.

Another large provider of equipment which came into the spotlight at the time of the Gulf spill is Cameron International Corp (CAM:NYQ), a provider of flow equipment products, systems and services. CAM manufactured the 'blow out preventer' (BOP), a towering 400 ton stack of valves designed to seal and control oil and gas wells, used on Transocean’s Deepwater Horizon drilling rig. NOV, CAM and General Electric's (GE:NYQ) Hydril Pressure Control unit dominate the market for these giant engineering marvels, which cost upwards of $45m each, and all these groups should be big beneficiaries of the investment in new high-tech rigs and the increasing focus on safety, with many new rigs getting a second back-up BOP device.

UK investors will be familiar with Weir Group (WEIR:LSE), the UK-listed manufacturer of pumps and ancillary equipment, a large percentage of whose business comes from the oil and gas sector. The need to look further afield when assessing this sector is highlighted by Weir's US-listed peer Flowserve Corp (FLS:NYQ), another similar-sized provider of flow control products, whose shares have outperformed the UK group over the past 12 months.

 

 

OILFIELD SERVICES

In addition to Schlumberger, the dominant oilfield services groups are all US listed, with Halliburton (HAL:NYQ) and Baker Hughes (BHI:NYQ) the leading names. The share prices of both have suffered over the past few years due to their exposure to declining North American activity and, in the case of Halliburton, involvement in the Gulf spill. With the valuations of both modest by historic standards and recent results from HAL quite promising, 2013 could witness a rebound in their share prices.

There is a diverse number of other businesses supporting the energy sector both onshore and offshore and many engineering groups, such as the UK's Rotork (ROR: LSE), where exposure to oil and gas and power markets dominates.

As new deep-water drilling rigs come on to the market, providers of subsea engineering and equipment such as Paris-listed Technip (TEC:PAR) and Oslo-listed Subsea 7 (SUBC:OSL), created as a result of the merger of Acergy S.A. and Subsea 7 Inc, should do very well. As the leading provider of remote operating vehicles supporting the offshore oil and gas industry Oceaneering International (OII:NYQ) should also benefit, although with the shares trading at just over 19 times consensus estimates for 2013, the valuation will look high to some, despite the group's excellent qualities and consistent performance.

Little choice for passive investors

Passive investors who prefer investing via an exchange traded fund will be disappointed as there is no global index fund offering exposure to the world of oil equipment and services. The closest is the Philadelphia Oil Service Sector Index (IND: OSX) which is a price-weighted index composed of 15 US-listed companies that provide oil drilling and production services, oil field equipment, support services and geophysical/reservoir services.