Schlumberger, Halliburton Are Currently Attractive

The oil and gas industry looks very attractive on both a relative and an absolute basis. Of the ten industries in the Industry Classification Benchmark (ICB) structure, Oil & Gas conspicuously has the highest median RBP Probability. It is currently 80%, considerably higher than the market median of 75%, and the highest among all industries.

What I notice is that the above-average RBP Probability of the industry is driven entirely by the equipment & services subsector. What is certainly NOT driving the high median are the pipeline companies. Kinder Morgan Partners (KMI), for example, has an RBP Probability of 45.5%. Nor are the Integrated Oil & Gas companies – the so-called “big oil” companies – driving the results. Exxon Mobil (XOM) currently has a RBP Probability of only 70%, Chevron (CVX) only 74% and and Conoco Phillips (COP) only 46%. In fact, the Integrated Oil & Gas subsector as a whole boasts an RBP Probability of only 66%.

This is important because oftentimes when investors want exposure to the oil industry they resort to these big names, expecting the performance of them to proxy for that of the industry. Yet the recent past has shown us they often do not.

Even though over the past three months the return to the Integrated Oil and Gas subsector has actually been -1.9%, all while the market has put together a 15% rally, this does not mean the big oil companies represent a bargain. The strengthening of the dollar has made producing revenues comparable to those of 2007 and 2008 far more difficult, and current stock prices are not fully reflective of this fact. Spot oil prices will need to increase by as much as 50% to allow Exxon and Chevron to have a realistic chance of producing the performance implied by the current price of their stock - their Required Business Performances. This is not impossible, but it decreases the probability that either company will meet its RBP, and thus both have relative low RBP Probabilities.

The areas of the Oil & Gas industry where the opportunities seem most promising are in the oil services, which are not affected as directly by the spot price of oil. Schlumberger (SLB) currently has an RBP Probability of 98.2%. (See SLB’s RBP Snapshot as of May 20) Halliburton (HAL) has an RBP Probability of 98.4%. (See HAL’s RBP Snapshot as of May 20) It is easy to see why by taking a look at the Company RBP snapshots. The twelve month returns to SLB and HAL respectively are -48% and -57%. This makes both companies’ Required Business Performance extraordinarily low.

While SLB revenue grew by 11.5% for the twelve months ended 3/31/09, the current stock price implies that revenue will decline by 9.4% over the next twelve months, then resume historical growth rates. Similarly, HAL revenue grew by 14.4% over the twelve months ended March 2009, yet its current price implies negative growth of 7.3% in revenue.

When the market is pricing certain companies to show sharp drops in operating performance, it is worth the time to determine how likely such drops actually are. Nothing is completely certain, but based on the past performance of both Schlumberger and Halliburton, it seems highly probable that both will deliver performance over the next twelve months that will support the prices of their stocks today.