Source of opportunity
GS believes recent production data has de-risked forecasts of an oil price and US rig count recovery in 2017. Our oil team now expects the horizontal rig count to rise 57% in 2017 and we expect this to drive 9% org. growth for Weir (20% of US upstream sales). Despite our view that 2016 will mark trough earnings, Weir trades on 15.8x 2016E P/E (in line with history/sector, 10x 2017E P/E). While the stock has been strong over the last month it has underperformed peers and our SOTP implies its O&G business is a c.50% discount to peers. Downside appears limited given 4.2% 2016E div yield, on our stress test covenants are not breached & dividends are cash covered.
Catalyst
As a result, we reiterate our Buy and add the shares to the Conviction List with 30% upside. Rig count, which we expect to trough in 2Q, is the key catalyst. The US horizontal rig count is now at levels not seen since 2006/07,
before fracking was fully commercialized. We believe Weir is currently pricing a modest rig count recovery of just 10% next year so any indication that this will be insufficient should support the stock. We remain cautious on mining aftermarket, and assume a mid-single digit top line decline (in line with rest of coverage; management expects 2016 to be flattish).
Valuation
Our EBIT estimates fall 1%/9% for 2016/17 as we reflect GS’ latest rig count forecast, however our 12-month price target remains 1,350p (we roll forward our estimates). We value Weir using our sector relative EV/IC vs. ROIC/WACC framework. Our valuation continues to includes an M&A component at 14x EV/EBIT (based on mining equipment deals over the last ten years), weighted at 15%.
Key risks
Key risks to our view and price target are worse-than-expected declines in mining aftermarket, disappointing global oil demand meaning required shale recovery is lower than expected.