Oil services in 2016: Focus on working capital, valuation
We expect cash outflows on working capital, risks to profit
In this report, we focus on working capital analysis, which we believe will
be the key theme for the oil services sector in 2016. As low oil prices lead
to negative free cash flow generation for oil producers, we believe oil
services companies will face delayed payments that they will largely have
to accept given the high competition for new orders created by a lack of
order intake in the industry. We expect a negative funding gap, mostly
driven by a build-up of receivables. We highlight Tenaris and Hunting as
having opportunities to destock, while we see working capital risks for
Petrofac, Wood Group, Aker Solutions, Fugro, PGS and CGG.
Valuation: Sector at trough EV/GCI; coverage view up to Neutral
We have long argued that in order to turn less bearish on the sector, we
would need to see it trading at trough EV/GCI – a point at which valuation
would reflect the fundamental shifts and structural deflation in the industry.
Following the ytd sell-off, we believe the sector is now trading at trough
EV/GCI, and thus raise our coverage view to Neutral from Cautious. We
move from an EV/EBITDA-based valuation to an EV/GCI framework and
update our estimates to reflect recent market trends.
Buy structural winners, sell deepwater/cash-squeezed companies
We view the sector’s current trough EV/GCI valuation as offering an
attractive entry point into industry leaders with strong balance sheets,
namely Technip and Tenaris, which we upgrade to Buy from Neutral. We
would avoid E&Cs that appear at risk of a build-up in receivables and therefore
an expanding funding gap, putting pressure on cash flow generation. We
downgrade Petrofac to Neutral from Buy on receivables build-up risks and a
more moderate outlook for order intake in the Middle East. We downgrade
Aker Solutions to Sell from Neutral as we expect increasing competition in
the subsea market in the absence of orders from integrated oils, and think
the risk of receivables build-up is also high. For the same reasons, we remain
Sell rated on Subsea 7. We also downgrade Wood Group to Sell (from
Neutral) and add it to our Conviction List, as we see risks of a material miss
vs. 2016 consensus expectations given indications of spending cuts from US
E&Ps and muted North Sea activity. In our view, the market overestimates the
company’s resilience in the current environment. We reiterate our CL-Buy on
Hunting based on the strong recovery we expect in 2017 in the US, to which
the company is geared. Hunting also screens as a potential M&A candidate.