Oil & Gas Equipment & Services: Feedback from launch of US-based providers
Investor feedback, common pushback, and the unexpected
Our view: This note contains a summary of feedback we have received since we launched coverage of eight US-based oilfield services and equipment providers on September 8. Our sector thesis calls for a managed-upcycle as global rig counts continue to improve through 2022, but governed by persistent E&P capital discipline. Overall, investors have been receptive to our thesis and we sense that investor portfolios are still conservatively positioned in the largest, most liquid stocks. We take this as a sign that the upcycle is in relatively early stages, as we believe investors tend to go down-cap as performance becomes clearer.
Thesis feedback: Investors becoming bullish, but fund allocations remain conservative. Most investors seem to agree with our call for higher US rig counts through 2022. On the flip side, continued E&P capital discipline and potential resumption of spare OPEC+ oil production capacity remain headwinds to higher industry capital spending. We sense that many bullish investors are still sticking with a conservative allocation to the lower-relative beta oilfield services names as entry exposure to the space as near-term industry challenges are addressed. In past months, we saw similar dynamics with E&P stocks, where investors now appear to be looking down-cap for higher beta exposure. We could see a similar trend play out in the services as a recovery takes shape.
Common pushback: Why OFS when E&P stocks offer such attractive FCF yields? For context, RBC’s Global Integrated and E&P Comparative Valuation shows North American Senior E&P free cash flow yields averaging 18% in 2022, versus OFS average of 9% (Exhibit 2). We agree with the sentiment but do not necessarily see the equation as an either-or decision. We believe the best-positioned stocks will perform well as global rig counts increase over the next 12 months, particularly those with strong operating leverage and relatively stable capital spending requirements. Oilfield Services also remain a way to gain exposure to oil & gas commodity cycles without direct investment in producing assets.
Interest in Canadian OFS names perked up. Perhaps unexpectedly, the launch prompted increased interest in Canada-based oilfield services providers from Canada-based investors. In addition to investor conference season, we see two reasons for increased interest in Canadian names. First, Canadian stocks now trade at an average EV/EBITDA discount to US names of 3.1x, and many stocks are trading at historically low valuation levels. Second, the Western Canadian rig count remains strong, running ahead of the seasonally strong first-quarter average.
ESG considerations. Unsurprisingly, ESG considerations are particularly topical among generalist investors where stocks compete for capital across sectors. Investors are concerned about the actions needed for service providers to hit their own emissions reduction targets and providers’ ability to earn revenue from E&P de-carbonization. Investors generally agree that more details on resource allocation and road-mapping toward emissions-reduction and other ESG targets would increase comfort levels.
Preferred stocks. As a reminder, our preferred stocks are BKR, SLB, HP, SES, and PSI.