Somber Near-Term Outlook for Oil & Gas Equipment Industry

The Zacks Oil and Gas-Mechanical and Equipment industry comprises companies that provide necessary oilfield equipment, including production machinery, pumps, valves, along with several other drilling appliances like drilling rigs and rig components, to exploration and production companies. These help the upstream players in the extraction of oil from fields, both onshore and offshore.

Let's take a look at the industry's three major themes:

  • The oil and gas equipment industry is heavily reliant upon production companies' capital spending, which is in turn influenced by oil and gas prices. Higher commodity prices boost the spending levels of upstream players, as they can derive more value for their products. Generally, when oil drilling and production becomes profitable for the exploration companies on the back of commodity price uptick, the demand for equipment providers increases and their business prospects also improve. Conversely, if crude prices tumble, the oilfield equipments industry is likely to be one of the first ones to feel the pinch. Notably, oil prices have been dipping into bear-market territory of late, after touching multi-year highs of more than $76 a barrel in early October. Since then, the commodity has plunged more than 30% on fears of oversupply and weakening oil demand. Renewed concerns over economic slowdown and U.S.-China trade tiff may further weaken oil prices. Amid the growing crisis, most of the energy companies are forced to slash their capex in 2019, which may spell further trouble for the oil equipment industry.

  • Oil equipment providers suffered the most during the three-year oil slump since mid 2014, as the top line of the companies belonging to this industry dwindled much quicker than upstream players, courtesy of producers limiting their purchases. However, it's not just about the commodity prices. Despite crude being on an upward trajectory for most part of 2018 and shale producers reaping profits, the situation has not translated into a rosier scenario for equipment suppliers due to various factors. Notably, during the crude downturn, the upstream players invested in cost-cutting measures to keep drilling activities economical in the low-price environment. Investments in technological advancements, involving pad drilling and rig mobility, have led to efficiency gains for producers but softened revenues for oil equipment companies. Moreover, infrastructural bottlenecks in North America (which accounts for around 40% of the oilfield equipment market) and Canada are contracting drilling activities and hurting equipment providers. Cost inflation, along with labor and equipment shortages are further worsening matters for the oil equipment industry.

  • Oilfield equipment providers are capital-intensive companies and are reeling under heavy debt burden along with lower cash flows. During the downturn, demand for equipment reduced sharply, with various assets getting impaired and debt ratios escalating. In fact, it is likely to become difficult for these companies to repay their long-term debts, unless they witness a surge in cash flows. The staggering debt levels will certainly weigh on their near-term credit quality. Financially distressed companies certainly face various limitations, and are more susceptible to volatility as well as sudden economic changes. Needless to say, while the large-cap firms are more poised to regain their credit strength, the smaller rivals are likely to go through a rougher patch. Another thing worth noticing here is the fact that while the oilfield equipment providers focusing on onshore development may get some relief from the boost in drilling activities, those supplying equipments for the offshore markets will be the worst sufferers.

Zacks Rank Indicates Tepid Prospects

The Zacks Oil and Gas - Mechanical and Equipment Industry is a 15-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #226, which places it in the bottom 13% of more than 250 Zacks industries.

The group's Zacks Industry Rank , which is basically the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group's bottom-line growth potential. The industry's earnings estimates for the current year have declined almost 123% over the past year.

Before we present a few stocks that you may want to consider for your portfolio, let's take a look at the industry's recent stock market performance and valuation picture.

Industry Lags Sector & S&P 500

The Zacks Oil and Gas - Mechanical and Equipment Industry has significantly underperformed the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 Composite over the past year. Capital discipline by upstream players, dearth of labor and pipeline crisis have weighed on the industry in recent times, reflecting disappointing results for the firms.

The industry has declined 37% over this period versus the S&P 500's decline of 5% and broader sector's fall of 13.8%.

One-Year Price Performance

Industry's Current Valuation

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing oil and gas drilling stocks, the industry is currently trading at 18.62X compared with the S&P 500's 10.38X and sector's 5.17X.

Over the past five years, the industry has traded as high as 46.19X, as low as 5.26X and at the median of 10.30X, as depicted in the chart below.

Bottom Line

Notably, the Mechanical and Equipment industry has been grappling with contraction of activities and decreased spending. Moreover, pipeline woes and labor inadequacy have aggravated the predicament of equipment providers. Further, pipeline concerns are escalating and operators are resorting to slowdown in production, which is likely to affect the industry. With infrastructural log jams likely to take another year to get in place, the short-term prospects of the mechanical and equipment industry look challenging.

Hence, the industry might not be an appropriate choice for investment going forward, owing to the prevalent headwinds. Poor price performance, stretched valuation and south bound earnings estimate revisions mirror bleak prospects of the industry.

Consequently, none of the stocks in the oil equipment industry currently sport a Zacks Rank #1 (Strong Buy) or 2 (Buy). However, we are presenting a few stocks with a Zacks Rank #3 (Hold), which investors might be interested in.

McDermott International, Inc. (MDR): The Zacks Consensus Estimate for Houston, Texas-based McDermott's 2019 EPS has remained unchanged at $1.51 per share over the past 60 days.

Price and Conensus: MDR

Matrix Service Co. (MTRX): The consensus mark Oklahoma-based Matrix Service's current-year bottom line per share of $1.01 has remained stable over the past 60 days.

Price and Consensus: MTRX

Profire Energy, Inc. (PFIE): The consensus estimate for Utah-based Profire Energy's current-year EPS of $0.17 has remain unchanged over the past 60 days.

Price and Consensus: PFIE

Ion Geophysical Corp. (IO): The Zacks Consensus Estimate for 2019 loss per share of this Texas-based company has remained stable at $0.30 over the past 60 days.

Price and Consensus: IO

(You can see the complete list of today's Zacks #1 Rank stocks here. )

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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.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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