Wednesday, January 6, 2010

Oil Services Outlook for 2010: Rally to Continue in First Half

Oil Services

Outlook for 2010: Rally to Continue in First Half

Earnings upgrades to drive further outperformance: After oil prices bottomed out in March 2009, the sector’s PE multiple started to increase from ~5x to the current value of ~17x. As a result, the sector rallied strongly in 2009, up ~132%. Currently, valuation multiples are broadly in-line with their historical averages again. However, we still anticipate outperformance in the first half of 2010 driven by upgrades to 2011 consensus forecasts. Our top picks are PGS and Acergy, based on expected EPS upgrade potential, as well as Wood Group and SBM Offshore, based on valuation.

E&P spending set to rise: At US$70-80/b, oil prices are sufficiently high to make the vast majority of upstream projects economically attractive. In addition, oilfield service costs are reaching their cyclical troughs, which removes an important incentive for oil companies to delay investments. With a large ‘inventory’ of delayed, un-awarded projects available, the rate of contract awards is set to increase in 2010. Channel checks suggest this process is ongoing.

2011 consensus EPS 14-40% too low for most: An increase in contract awards should allow oil service contractors to increase order intake and rebuild their backlogs again. After the earnings downgrades of late 2008/early 2009, we now find 2011 consensus EPS estimates undemanding. PE multiples no constraint to outperformance:

PE multiples are at a ‘normal’ level again, if not somewhat higher. However, the oil services sector has historically shown no relationship between multiples at the start of a period and subsequent equity returns. Hence, we don’t expect this to be a constraint to outperformance yet. Start of tightening is a risk later in 2010: Later in 2010, our strategists expect monetary tightening to lead to concerns over 2011 growth and a period of market consolidation/correction. Due to its high-beta and GDP sensitivity, this is a risk for the sector.

[morgan stanley]

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