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Fund Spy: Global funds an entry point to undervalued oil services

Glenn Freeman  |  14 Oct 2019Text size  Decrease  Increase  |  
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Funds from Aberdeen Standard and Fidelity can provide investor exposure to parts of the oilfield services sector, which a new Morningstar report views as around 35 per cent undervalued.

A handful of global companies that provide services to oil and gas producers are being underestimated by the market, with share prices in the subsector trading an average of 35 per cent below Morningstar's fair value estimate.

The likes of Schlumberger, Haliburton and Baker Hughes are among those that will benefit from rising capital expenditure over the next five years, says Morningstar equity analyst Preston Caldwell in an October Energy Observer report.

Morningstar expects oil and gas capex on oilfield services to top 16 per cent over the next five years, far outstripping the 6 per cent capex growth forecast of the broader market. This is a key reason several companies in the segment are undervalued.

Market is implying about 6pc cumulative oil and gas capex through 2023

oilfield services

Source: Company filings, Morningstar

Caldwell believes the market is wrong in conflating the rapid efficiency improvements in US shale gas production with the conventional producers, who extract oil and gas from wells sunk in onshore and offshore locations.

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"At present, it appears that consensus is making the opposite mistake as a year ago: expecting ex-shale global oil production to be able to copy US shale's path of dramatic cost reductions," Caldwell says.

"Conventional onshore and offshore producers are often neglected compared with higher-profile US shale or deepwater, but still account for the lion's share of global oil and gas production as well as expenditure," he says.

Market overlooking potential

With ageing reservoirs and a "depletion of low-hanging fruit", Caldwell says efficiency improvements among conventional oil and gas producers aren't able to offset the declining resource quality. This means they increasingly have to rely on oilfield services providers.
But investors are overly pessimistic about the prospects for growth among some of these companies, a number of which Morningstar awards moats of competitive advantage and which are currently undervalued versus analysts' fair value estimates.

One such narrow moat, five-star stock - which reflects its price relative to Morningstar's fair value - is Schlumberger. It stands out for "unrivalled expertise" in understanding oil and gas reservoirs, having been a front-runner since the 1920s, says Caldwell.

It was one of the pioneers of what is known as directional drilling, particularly horizontal drilling, which transformed the oil and gas sector in providing access to resource deposits in previously inaccessible locations.

Schlumberger is currently trading at a 50 per cent discount to Morningstar's fair value estimate of US$60, having last closed at US$31.07.

Segment is split, says Aberdeen Standard

Camille Simeon, investment manager and global energy sector lead, Aberdeen Standard Investments Australia, says the oilfield services sector has been hit particularly hard by oil price volatility.

"The sub-sector was off 13 per cent last quarter, and has been trading on about five-year lows. And there's certainly been parts of that sub-sector that has felt more pain than others, with [share prices of] those concentrated on North America off by 53 per cent," she says.
"But around capex…the work that's coming through with international and offshore producers and a number of large LNG projects, it's driving some improving outlook and is positive for certain OFS names."

For this reason, Schlumberger appeals within the segment, because of its international focus beyond the US and its diverse business lines.

Aberdeen Standard International Equity Fund (4768), which holds a Morningstar Bronze, invests 2.27 per cent of its portfolio in Schlumberger.

Morningstar rates the fund as positive across its process, management and research team and price. Manager research analyst Michael Malseed describes Aberdeen Standard's portfolio as one which diverts meaningfully from the index and peers, both in the sectors it includes and the countries it covers.

"The team has a long-term quality philosophy, and is made up of 10 portfolio managers that share decision-making duties. Not only are the team’s insights generally solid, but it has remained stable over time, including since the 2017 merger of Aberdeen and Standard Life," Malseed says.

Morningstar's Caldwell believes that Baker Hughes' oilfield-services segment will see revenues rebound from trough levels, to end roughly in line with oilfield-services peers like Schlumberger and Halliburton.

Fidelity Global Equities (4897) holds a portfolio weighing of just under 1 per cent in Baker Hughes.

And in the deepwater segment of oilfield services, which Caldwell expects will see the sharpest turnaround in capex, he highlights TechnipFMC and Subsea 7, which are trading around 35 per cent below Morningstar's fair value estimates.

Solid value in deepwater

Technip's offshore oil and gas division was recently part of a major merger, which creates big opportunities for cost savings within the segment, which has in the past been marked by ballooning costs.

"We think Technip will grow most strongly thanks to its peer-leading integrated project offerings.

"Owing to a more consolidated industry as well as other factors, we expect subsea engineering and construction to continue to fare much better than offshore drilling," Caldwell says.

Caldwell recently raised his fair value estimate for Subsea 7, one of the big three subsea engineering and construction firms alongside Technip and Saipem, to US$35 a share, from US$33.

"Overall, the offshore engineering and construction companies are one of the best ways to play our thesis that the market is underrating global oil and gas capital expenditure growth in coming years," he says.

is senior editor for Morningstar Australia

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