Oilfield Services Q2 Preview: It's Not All Gloom and Doom
As is the norm, oil services companies – providers of technical products and services to drillers of oil and gas wells – will kick off the second-quarter 2020 earnings season for U.S. energy firms. With the price of WTI crude down more than 30% year to date even after the stunning rebound since May, 2020 has turned out to be a tough one for oilfield services stocks.
The slump in oil prices and coronavirus-induced demand shock has pushed drilling activity lower by introducing tremendous uncertainty around the exploration and production (E&P) spending outlook. From supermajor ExxonMobil XOM to smaller players like Oasis Petroleum, all have made drastic cuts to their capital expenditures in an attempt to preserve cash and stay afloat. Obviously, this translates into lesser work for the companies that make it possible for upstream players to drill for oil and gas.
As supplier of technology, solution and parts to the E&P sector, the sentiment toward the oil services firms is rather pessimistic ahead of their reports. Consequently, most sector components – including well-established big names like Schlumberger SLB, Halliburton HAL and Baker Hughes BKR – are likely to report weak year-over-year earnings.
Let's take a look at the key items impacting oilfield services companies' revenues and earnings.
Oil Prices Remain Unprofitable for Drilling: Strong commodity prices typically lead to robust upstream activities. As exploration, drilling, and production picks up, oil service providers see a surge in their sales and profitability. While the West Texas Intermediate (or WTI) crude oil prices almost doubled in the June quarter due to easing lockdown measures and an uptick in demand, they are barely at $40 a barrel – a level where most E&P firms are struggling to turn a profit.
Moreover, this is certainly not enough to trigger investments in mature field development, exploring unconventional resources, or expanding offshore programs. This slowdown in activity hurts overall demand for services and equipment across the industry spectrum and does not bode well for the upcoming earnings season.
Sharp Cut in North American Activity: The North American market remains a key driver of revenue for oil service firms. As such, the rig count in the United States is another yardstick in determining exploration spending by producers and therefore, the health of oilfield service providers. Usually, the more operating rigs there are, the more oil service companies make in revenues.
Worryingly, during the second quarter of 2020, the U.S. rig count decreased by a staggering 463 units (from 728 to 265). In particular, rigs engaged in the exploration and production of oil fell to 181 in the week through Jul 10 – their lowest since 2009. The statistics suggest severe erosion in North American drilling and completion activity in the April-June timeframe. Oil service firms with sizable presence in the region are expected to have suffered heavily on this sentiment.
Pricing Pressure: The severe slowdown in North American drilling has led to pricing pressures for oil servicing firms, impacting their top line growth. While no operator is immune to lower product pricing, the situation is worse for smaller companies that are debt-heavy or cash flow negative and are unable to provide concessions to the E&P clients.
However, it's not all gloom and doom in the oilfield services market. There are still some bright spots.
International Projects Holding Up Better: While international E&Ps are also pulling back on spending due to continued weak oil prices, the degree of decline is likely to be less than North America. This is because most of these projects are backed by national oil companies and/or integrated majors that consider a long-term horizon. Moreover, a sizeable proportion of international projects are offshore that have been okayed over the past few years and are difficult to stop or cancel suddenly. It was because of resilience in the international business that the likes of Schlumberger and Halliburton were able to beat first-quarter earnings estimates.
Cost Reduction Efforts: Meanwhile, the companies have also done a fairly admirable job at reducing costs. Their cash outflows as capital expenditure continue to fall as the oil service firms reign in their spending levels. They are also pushing for reduction in overhead and other costs, while some like Halliburton and Helmerich & Payne HP realizing sizeable savings from cutting the dividend. All this should push the companies’ earnings and cash flows higher.
In a nutshell, the oilfield service fundamentals remain extremely bearish with most of the companies entirely focused on survival. From Core Laboratories CLB to ProPetro Holding to Oceaneering International, the company boards have adopted various strategies to survive the downturn. They have been lowering capital spending, furloughing employees and cutting executive pays. Even biggies like Halliburton and Schlumberger – both carrying a Zacks Rank #3 (Hold) - have announced a set of belt-tightening measures.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
The oil service companies will be in the limelight early next week as second-quarter earnings reports for the group start rolling in. Investors may want to take a cautious approach to the industry ahead of earnings. At the same time, analysts feel that the second quarter will likely indicate a bottom for the oilfield service industry with gradual recovery to follow.
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Exxon Mobil Corporation (XOM): Free Stock Analysis Report
Helmerich Payne, Inc. (HP): Free Stock Analysis Report
Schlumberger Limited (SLB): Free Stock Analysis Report
Halliburton Company (HAL): Free Stock Analysis Report
Core Laboratories N.V. (CLB): Free Stock Analysis Report
Baker Hughes Company (BKR): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.