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Analyst Interview Excerpt
OILFIELD SERVICES COMPANIES: ROBERT MACKENZIE - FRIEDMAN, BILLINGS, RAMSEY GROUP INC


Full article published: 06/16/2003


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TWST: Would you begin by telling us about FBR research in general, the clientele the firm is generally directed toward, and then how your specific coverage area fits into that overall game plan?
Mr. Mackenzie: FBR is a mid-sized investment bank covering six main verticals: energy, financial services, real estate, health care, technology, and diversified industrials. In the energy team, we have five senior analysts: myself, covering the oilfield services companies; David Khani and Rehan Rashid, covering the E&P stocks; Jacques Rousseau, covering the integrated oil companies and refiners; and Amir Arif, covering the Canadian E&P stocks. We also have a great support staff to help us excel. I currently cover 10 stocks in my universe: Schlumberger (SLB), Halliburton (HAL), Baker Hughes (BHI), BJ Services (BJS), Weatherford International (WFT), Smith International (SII), Cooper Cameron (CAM), FMC Technologies (FTI), Key Energy (KEG) and Core Laboratories (CLB).

TWST: As an overview of the industry, are there any particular assumptions or catalysts that are still having an impact as we look back over the past 12 months and then will have an impact looking ahead 12 months?
Mr. Mackenzie: Clearly, the major driving force over the past several months (and also going forward, in our opinion) is the continued strength in natural gas fundamentals in the US and Canada. We're seeing a continued decline in the production of natural gas ' down 5%-6% last year, probably a further 1%-3% in 2003, before starting to increase in 2004. We continue to foresee strength in natural gas prices both this year and next. We've recently heard concerns to that effect evidenced by both Federal Reserve Board Chairman Greenspan and Secretary of Energy Abraham, both of whom expressed public concern that domestic gas production may not be sufficient to meet the nation's needs come this winter. And we believe that's going to continue to drive increased activity in the oilfield services markets both in the United States and Canada. Our outlook is based on declining domestic supply, coupled with increased demand as a result of tighter environmental emissions restrictions on other forms of fossil-fuel-based power generation, particularly coal. Internationally, we're seeing a little bit of a rebound in Latin America and select other international markets. But broadly, we expect international activity to grow fairly slowly, somewhat in line with population and/or GDP growth around the world, a couple of percent both this year and next. That's the foundation for the group's earnings. Add to that some really strong increases in North American activity, and we see substantial upside to earnings and stock price potential for most oilfield service companies. Now, within that, the way I've tended to look at the oilfield services space so far is to try to identify those services within the industry and, by inference, those companies that I believe, based on my industry background, will grow faster than the overall industry. Generally, those are services that tend to add value to the E&P companies. They're services that help E&P companies improve their economics, generate a greater return on their investment, and the like. We identified several of those services within the space and then started focusing on those companies that are the most highly leveraged to those services. That's shaped our thinking about some of the different stocks within the space. In addition to that, we have generated a unique valuation metric whereby we basically merge an intrinsic value analysis with a more traditional market-based multiple approach to come up with a methodology to compare how the market is valuing each company's expected economic value creation. We believe that's very useful for investors in separating one stock from the other. A good example of that would be BJ Services versus Smith International. Both companies are very highly leveraged to the North American market, where most of the activity increases are going to be going forward, as we pointed out; however, based on the relative services they're involved in, BJ Services has much greater profit leverage to increased North American activity than does Smith. Approximately 75% of BJ's revenues are derived from pressure pumping, which carries very high incremental margins, versus Smith, which has a variety of different services, one of which, Wilson, has much lower absolute and incremental margins. Just by way of comparison, because of their participation in different services, BJ's incremental margin in calendar year 2001 was about 50% versus Smith's in the low 20% range. So while both companies have similar revenue leverage to the North American market, BJ Services clearly has much more profit leverage to the market, and we can see a valuation discrepancy crop up there between the two favorite names to play gas with ' Smith looking much more expensive relative to its earnings potential and BJ looking much more attractive.

 

Tickers included in this excerpt: BHI, BJS, CAM, CLB, FTI, HAL, KEG, SII, SLB, WFT

 

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