When a £1bn business sees its share price rise more than 200% in a couple weeks it’s time to take notice

Opportunities in the beleaguered oil service sector

The oil price has staged a surprise (at least to many!) recovery over the past few weeks with Brent up nearly 50% from the January lows to just over US$40 and WTI up just over 34%. Russia’s talk of a production freeze and, more recently, news of Ecuador hosting a meeting of Latin American crude producers has evidently offered encouragement. The smaller-than-expected build in stockpiles at the Cushing, Oklahoma delivery hub for U.S. crude is also helping.

The encouraging news has also offered support to the beleaguered oil services sector with several stocks in our universe seeing material increases, one of which has seen its share price rise more than 200% in a matter of weeks. If we were talking about some micro-cap minnow this wouldn’t be remarkable, however the stock in question is one of the giants of the sector and a business which generated revenues of over £5bn and an operating profit of near £1bn in the last reported financial year. We think it’s time to take a closer look at the fraught oil services sector.

The giant in question that has seen its shares rebound so materially is the US and Norwegian listed offshore driller, Seadrill (SDRL) whose shares have now risen more than 200% over the past 2 weeks, more than doubling in a single day on huge trading volume, yet no company specific news. That’s a mighty move for a business with a market capitalisation of approximately US$2.5bn currently. Seadrill evidently has plenty of issues, including a decidedly less rosy forward outlook and US$billions in debt maturities coming due over the next few years. However, it highlights the potential opportunities in a sector that has had little to cheer about over the past few years.

The press has also once again dug out the possibility of Weir Group (WEIR), the UK listed manufacturer of pumps and valves, being a possible target for US listed General Electric or Flowserve. We think cash rich US industrial buyers will be inclined to sit on the sidelines for the time being, especially with continuing sterling weakness on Brexit fears. In the meantime Weir has a tough job ahead.

Recent full year results from Hunting (HTG) were predictably awful with the reported loss for the year ending 31st December 2015 US$227m including heaps of impairments. More positively free cash flow of US$118.0m was quite good and net debt of US$115m quite modest and extremely manageable. We struggle to see the value in Hunting at current levels and are very surprised how the share price has bounced so strongly.

The midstream energy sector in the US received a blow yesterday from the US courts as a judge allowed Sabine Oil & Gas, a shale energy producer under Chapter 11 bankruptcy protection, permission to break contracts with two pipeline companies so it could pursue better deals. The midstream sector encompasses the gathering, processing, transportation and storage of oil and gas and has been viewed as a ‘safer’ sub-sector of the oil and gas arena in the US (although share prices have still tumbled) with the view that long term contracts were virtually unbreakable, thereby offering greater certainty over the large dividends that midstream players pay out. This latest ruling therefore brings that whole rationale into question and saw investors subsequently selling out of the pipeline companies. With the share prices of pipeline operators decimated over the past 12 months, largely due to fears surrounding their large debt burdens, this sub-sector could offer some interesting pickings……for the brave.

A research note from energy specialists Simmons & Company highlighted the growing forward supply challenge in the oil sector. Simmons & Company observed that since the July 2014 peak, the international rig count has declined in 15 of the preceding 19 months and is now 26% lower from the recent peak. With the exception of the Middle East, all of the other major international regions have contracted by 30-43%. Simmons & Company believes that “imploding exploration will have grievous consequences to forward supply.”

 

We continue to believe that the struggling energy sector will offer meaningful investment upside over the next few years for investors willing to look beyond the current uncertainty.

For the latest fact sheet on our energy, equipment and services fund please visit our Publications page here