U.S. Oil Services & Drilling: 2013 Outlook: The Mega-Cycle Rolls On

U.S. Oil Services & Drilling: 2013 Outlook: The Mega-Cycle Rolls On

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The mega cycle for the oil services industry will continue in 2013, in our view, though it remains largely obscured by concerns over the "fiscal cliff" in the U.S., an unsteady recovery in China, the ongoing debt saga in Europe and depressed equity valuations globally. Despite the macro anxieties, the reason to own oil services stocks remains clear, in our view: the world is increasingly short energy, hydrocarbon prices are at attractive levels for investment and are likely to rise further, CAPEX on energy investments is growing and, as the bottleneck, the oil services companies are likely to capture the lion's share of the economic benefit of this unfolding trend. We remain bullish on the oil services, equipment and drilling companies and expect the group to significantly outperform the broader equity market over the next several years.

Several Major Themes Driving the Upcycle: This cycle is being defined by several "super themes," in our view, including: a strong international upcycle, substantial growth underway offshore and in particular in deepwater and subsea, a relatively resilient North American land market, the re-birth of exploration, the equipment revolution that is reshaping the oil and gas industry, and the buildout of energy infrastructure. Other themes include the pursuit of a more complete and optimized subsea system, a potential recovery in natural gas activity in NAM, the creation of a global LNG market, the exportation of shale activity to international markets (a major theme by mid-decade), and an increase in mature field investments.

E&P Spending to Reach Record Levels: Global E&P spending is set to reach a new record of $644 billion in 2013, up 7% from 2012 levels. CAPEX growth in 2013 should be almost entirely driven by the international markets, where we estimate budgets will jump 9% as the international and offshore cycles continue to build momentum and commodity prices remain at attractive levels. Sustained high oil prices, the sanctioning of major projects, and the delivery of a large number of offshore rigs in 2012 and 2013 are driving the increases. In contrast to international, North American spending is forecast to pause, with flattish YoY spending intentions in both the U.S. and Canada in 2013. This follows several years of strong growth.

Raising Price Targets Across the Board: We are rolling our price target derivations to 2014 earnings/EBITDA and raising our price targets for the oil services, equipment and drilling stocks across the board. The average upside to our price targets is 46%. With depressed valuations across the space, we would take advantage of the opportunity to own quality names with differentiated offerings at attractive valuations rather than chasing beta via the more commoditized plays. Therefore, we recommend building or adding to positions in large-cap, high-quality companies such as HAL, SLB, BHI, CAM and NOV. Offshore we believe RDC and NE are the most compelling among drillers pursuing sizable deepwater newbuild programs. We also remain constructive on two special situation/turnaround stories with potential catalysts in WFT and RIG. In the smaller cap growth arena, we prefer to own OIS, SPN and HOS.

Company-specific outlooks and catalysts for all stocks in our coverage universe are inside this report.

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