Wednesday, November 28, 2007 8:14:17 PM
By NAUREEN S. MALIK
Correction:
OIL STATES INTERNATIONAL COULD POSSIBLY be the most misunderstood company among the providers of equipment and services to oil and gas producers.
The stock lately has been thrown out with other energy-service providers whose fortunes are more closely tied to the vagaries of commodity prices. Its shares have tumbled 36% since early October's record high.
But Oil States is more of a mini conglomerate that has consistently generated double-digit earnings growth from diverse product offerings that range from tubing used to extract oil and gas to on-site lodging for workers. Its deepwater drilling and lodging segments are two hot areas of the energy sector that offer opportunities for strong earnings visibility and growth in the coming year.
The company, more than many of its competitors, has the flexibility to shift its focus from gas to oil and toward products that are in demand.
Right now that means downplaying rental equipment and tubing to focus more offshore production and worker accommodations.
Oil States has a record backlog in deepwater drilling contracts and is the leading provider of traditional remote-site housing and executive lodging (including suites for middle and upper management, recreation facilities and meeting rooms) in Canadian oil sands.
A third-quarter earnings miss, partially due to margin pressure and news that Alberta is raising taxes on production out of its oil sands, sent investors scurrying. That put an abrupt end to this year's rally. Shares, which traded at $25 in January, then raced to an all-time high of $50.98 on Oct. 10, closed at $32.76 on Tuesday.
At a Glance
Oil States International
Stock Price: $32.76
52-Wk High: $50.98
52-Wk Low: $26.92
Market Cap: $1.64 billion
Est. 2008 EPS: $4.08
2008 P/E: 8x
Est. Long-Term EPS Growth: * N/A
Est. ('08/'07) EPS Growth: 37%
Revenue (trailing 12 months): $1.99 billion
Dividend Yield: None
Chief Executive Officer: Cindy B. Taylor
Headquarters: Houston, Texas
* Based on analyst estimates looking ahead three to five years.
Sources: Yahoo! Finance, Thomson First Call, Thomson Financial/BaselineThis pullback is overdone.
Alex Roepers, president of Atlantic Investment Management, says Oil States is "in the penalty box because they missed the exact [earnings per share] number, but the overall story doesn't change."
The company generates $2 billion in revenues and is expected to earn over $4 per share in 2008, Roepers says.
Plus, with strong cash flow and a solid balance sheet the company can grow organically by adding new products as well as by acquisitions. Oil States continues to repurchase shares and could step up this effort given recent share-price weakness.
Looking at the valuation, Roepers says: "My God, it's a steal." He sold off a chunk of his firm's position earlier this year only to buy it back and more in the $30-range.
The price-to-earnings multiple has contracted from around 12 times earnings estimates for the next four quarters to 8 times.
Analysts surveyed by Thomson Financial expect the stock to gain 36% over the next twelve months. Roepers think shares could leap more than 80% if the valuation expands back to 12 times.
Oil States operates under three business segments: offshore products (21% of earnings before interest, taxes, depreciation and amortization), well site services (66%) and tubular services (13%).
Cindy Taylor, the chief executive officer and president of Oil States, says that about half of the company's earnings are driven from natural gas economics in North America.
While this is important, she says the stock market is writing off the company as a small-cap pure play in this space and overlooking "significant drivers tied to crude oil economics" through growth in global deepwater infrastructure and supporting development activity.
The higher royalty payments in Alberta sparked a knee-jerk sell reaction among investors, but Oil States' Taylor says that "it is our belief that the projects that are underway currently are going to move forward and that they aren't going to be abandoned."
In a month or so, she will have a better idea of the impact the tax will have on marginal projects for development in 2010 and 2011. The royalty payments would max out at 9% if oil reached the price of $120 per barrel but dwindle would down to zero if oil fell to $55 a barrel, she notes.
To date, 40 million Canadian dollars have been spent in the region and C$80 million is expected to be spent between 2006 and 2014. Camp and catering work is expected to be 2%-3% of that. Taylor says that Oil States is a leader in those services with very little competition.
While rentals of housing units may vary from month-to-month, Roepers says it is fairly stable with similarities to a "hotel business with large corporate clients that reserve large blocks."
The company's accommodation unit will generate 30% of earnings before interest and taxes in 2008, up from 20% in 2004, says Curtis Trimble, oilfield-services analyst at Canaccord Adams.
In the near-term, meeting the lowered fourth-quarter guidance and completing an oil sands accommodations project on budget early next year would fire up the stock, says Trimble.
CEO Taylor notes that the third-quarter numbers fell at the low end of guidance due in part to a favorable tax benefit and share dilution from convertible notes but undercut Wall Street estimates.
RBC Capital Markets analyst Victor Marchon says the offshore product unit is nearing revenue capacity and corporate moves to expand this business "underscores that [management] feels comfortable that the longer demand is there." This includes demand for flex joints and other connection pieces used for offshore infrastructure.
Oil States will likely bolster this business through cash-conscious acquisitions that are immediately accretive, he notes.
Meanwhile, a subdued natural gas market this summer, which was due to high inventory levels, will likely mean that production activity will not face a historical drop off in the fourth quarter notes Marchon.
To be sure, a sharp pullback in commodity prices, a warm winter or a recession could hurt producers' demand for services and Oil States profitability.
But even in a tough environment, Oil States' diverse business units offer a defensive play with limited downside risk and strong potential for returns. And that could prove beneficial for investors drilling beneath the surface of a turbulent market.
Regards,
frenchee
#board-4258 TSP Trend Timing: EFA (I), TLT (F), SPY (C), and VXF (S)
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