16 October 2012 Americas/United States Equity Research Oil & Gas Equipment & Services Oilfield Services Research Analysts INITIATION James Wicklund 214 979 4111 [email protected] Wait 'til You See the Whites of Their Eyes Jonathan Sisto 212 325 1292 Exhibit 1: Credit Suisse’s 16-Year Aggregate Timing Model [email protected] 15.0% 8.0% Brittany Commins Large Cap 6.0% Equipment 212 325 7128 10.0% Land Rigs [email protected] 4.0% Offshore Rigs 5.0% 2.0% Mid Small Cap Offshore Service 0.0% 0.0% Seismic Workover -2.0% -5.0% Construction -4.0% Boats -10.0% AVG -6.0% US Rig Seasonality -15.0% -8.0% Source: Company data and Credit Suisse. ■ Our View: Oilfield service stocks generally trade sideways for the balance of the year, typically against a rising rig count. Not only is the rig count dropping but it is likely to continue dropping for at least the next four to six months. Pricing, which many thought had bottomed, has taken another step down, the extent of which was only known to management after they closed the books for the quarter. This sets up earnings disappointment and we think earnings and expectations get reset. Other than the relative safety of the equipment sector, we see no reason to chase the stocks into year-end. ■ Differentiation: We are clearly positive on the longer-term, almost “secular,” growth potential of domestic drilling. While well-to-well consistency has still eluded the industry, the ability to produce shale/tight sands is still under- appreciated. But the capex requirements for the service industry have been huge and the industry is significantly under-capitalized for the international shale boom. That continuing high capital outlay is at the expense of returns and any DCF-based valuation having a significant impact on valuation and sector multiple differentiation. Something has to give, and it is never pretty. ■ Stock Calls: North American (NAM) services are seeing falling volume and price—never a good combination. HAL and BHI are most effected, SLB next, followed by WFT, under our coverage. Althoguh a bit crowded and already popular, the equipment companies should continue to outperform, especially through year-end. We are initiating on CAM and HAL at Outperform and on BHI, FTI, SLB, and WFT at Neutral. When the market can better discount the price dynamics and the activity dynamics, we believe investors will come back to the stocks. For now, we are neutral on the sector through year-end. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION™ Client-Driven Solutions, Insights, and Access 16 October 2012 Oil Services Initiation Highlights We are initiating coverage of the oilfield service and equipment space with a Market Weight position. Exhibit 2: Credit Suisse Oilfield Services & Equipment Coverage Universe 10/15/2012 Market Target Upside / Company Ticker Rating Price Cap ($MM) Price ($) Dow ns ide Jim Wicklund & Team Baker Hughes Inc. BHI Neutral $44.77 $19,679 $40 -11% Halliburton Company HAL Outperform $33.80 $31,358 $44 30% Schlumberger Limited SLB Neutral $72.19 $95,798 $66 -9% Weatherford International Ltd. WFT Neutral $12.17 $10,218 $11 -10% Cameron International Corp. CAM Outperform $53.22 $13,107 $75 41% Forum Energy Technologies Inc. FET Restricted $22.70 $1,946 FMC Technologies, Inc. FTI Neutral $44.02 $10,494 $49 11% Source: Bloomberg, Company data, and Credit Suisse estimates. Note: CS initiated coverage of Forum Energy Technologies (FET) in May 2012. Top Idea: Cameron International (CAM). It is risky because it is difficult to predict when or how management will fail to execute, but that is about the only thing that could get in the way. The company’s market positions have improved from regulation, acquisition and organic growth and with the longer-term growth potential in all types of manufacturing, as unappreciated as is the huge shift in capital allocation by the industry, it is in a number of sweet spots. We are initiating coverage of Halliburton (HAL) with an Outperform rating, though it is a bit qualified bias. The volatility to earnings from changes in price and activity in NAM completions is huge, and they are the biggest player. When both are going down, as they are now, get out of the way. When things are going up, load the boat. “When” is the issue and we are not sure it is now. We have discounted our computed multiple for HAL to risk that exposure yet still the valuation is exceptionally compelling. The company’s ability to generate improving returns and free cash flow will be a key issue. But overall, top management, excellent technology, and geographic depth are all distinct positives. It is just that things get better much more slowly than they get worse. We are initiating coverage of FMC Technologies (FTI) with a Neutral rating. FMC is the premier subsea equipment provider in the industry—period. A now $12 billion company that is the industry leader in the most defined growth sector is an enviable position. The increased number of rigs times the increased success rates of drilling equal higher and faster growth. But no company can wait for the future so growth is taking on some different directions. A problem contract lingers. Subsea pricing improvement is quarters away from hitting the income statement. Fabulous company but our valuation framework values it neutral. We are initiating coverage of Schlumberger (SLB) with a Neutral rating. SLB has been the 900-pound gorilla in the business forever. They lead the industry in technology, reach, and culture, with a huge number of ex-SLB people populating the top ranks of other service companies. It has the least NAM onshore service business of the Big 3, offshore is doing well, they own Russia and the seismic business has the best fundamentals of the industry right now and WesternGeco is the largest. But according to our matrix of valuation multiple versus economic return, SLB near-term appears over-valued. Trading at a ~60% premium to the closest peer that has better returns is difficult to justify. SLB could accelerate its returns and boost our valuation but our analysis shows that not likely to happen in 2013. We are initiating coverage of Weatherford International (WFT) with a Neutral rating. WFT is in limbo. It is too dangerous to be long or short. Longer term, we think long but there are hurdles ahead. Unabashed growth without enough back office discipline and Oilfield Services 2 16 October 2012 culture makes it the poster child of ramped-up capex at the expense of returns, and the ensuing crash. Fixes are being made but culture takes time. It isn’t enough to generate free cash flow, WFT has to have the processes, procedures and discipline to better manage capital. Hard to recommend without current financials. We are initiating coverage of Baker Hughes (BHI) with a Neutral rating. BHI is working on fixing a few things. When wheels come off in a slowing market, it is a double whammy. BHI will fix the pressure pumping business but first it needs some bigger customers with all that implies. Supply chain now under one roof is a big improvement. The cultural shift from product to geomarket always takes longer than expected but is well along. Martin is doing well. But the industry macro is not being BHI’s friend and while the company is right to try and gain better customers, it comes at a near-term cost. Divergence. Equipment design and manufacture overall well see excellent fundamentals for some time. The interruption of business from Macondo was longer lasting and slower coming back than had been hoped or expected. The ripple effect affected all market. Bids were lower with more concern about keeping a shop open than generating good margins. That has worked its way pretty much through the system. The consolidation has been fast and furious in the small private world. No so with service. Costs have hurt returns, low interest rates have fostered significant competition, a falling U.S. rigs count hurts. Preference. The DCFs of the equipment companies generally show significant upside from current values. Virtually all the service companies are under-water on the calculation. Different businesses have different dynamics but the DCF just looks at value from free cash flow. And that is the issue. The service companies have increased capex significantly over the past three to five years while returns have steadily dropped generating little, if any, free cash flow. The industry has changed. The capital equipment needed for the development of North American shale/tight sands reservoirs is huge. We see the well costs and think of the huge service cost inflation but much of that inflation is the service companies investing in the capital equipment they need to provide the service. And it will continue. We are significantly under-capitalized, as a service industry, for the eventual international shale boom. That is a key statement. We are going to have to do it all again for the international markets and keep it up, just like here. It is continual manufacturing that does not get to take much advantage of centralized locations.