The OSX drastically underperformed the S&P500 in 2014 as oil prices fell rapidly. Large cap service and equipment names proved most defensive, but no sub-sector was left untouched. We believe that sentiment is near a trough, and see a compelling risk-reward skew across most of our coverage.
* Large cap services & equipment defensive in 2014:
Though all subsectors posted negative performance in 2014, the Big 4 and equipment names were most defensive (-12% and -16% return respectively). The offshore drillers were the worst-performing group (-51% return) on floater market overcapacity and negative offshore activity revisions throughout the year. This underperformance was followed by OCTG (-50% return) as the industry dealt with oversupply fears, although the US trade case provided some relief for pricing. See full performance comparison on p.3.
* NAm onshore outperformed through July, but sold off rapidly:
NAm names outperformed through July on robust US onshore activity growth. We believe a hot debt market that allowed US E&Ps easy access to cash and declining unconventional well costs both caused activity to surprise vs. our initial expectations. However, this outperformance was short-lived as onshore stocks were among the hardest-hit during the October- December sell-off (Ex.3).
* Looking towards the next upcycle:
We believe that sentiment in the group is nearing a trough, as large-cap service & equipment names are trading well below historical P/S and P/B ratios (Ex.31-32). Our top picks into the trough include companies with high FCF conversion and stable balance sheets, particularly, SLB, CLB, and SDRL. We also tactically like high-beta NAm names (HAL, land drillers) as a way to play a highly attractively valued sector on medium-term view.