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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