On August 25, The Wall Street Transcript interviewed Neal Dingmann from Dahlman Rose, who focuses on the Oil Field Services and Exploration and Production sectors. Key excerpts follow:
TWST: What's your outlook, Neal, for the next year or two? Is it more of the same?
Mr. Dingmann: I think we do have more of the same. Right now obviously the biggest caveat out there is when people talk about demand destruction, given that the US still consumes about 4 times more than next guy out there, that being China, but all things considered, I just don't see any large supply coming in from any areas. And then you have areas like Mexico, Canada which all seem to be starting to produce less, so all these things combined, plus the tight spare capacity, leads me to still have a bullish stance.
TWST: And is the oil service industry gearing up to bring more equipment on line to meet this?
Mr. Dingmann: They are. If you look all the way from the largest company such as Schlumberger (SLB) down to micro-type players, one thing is very evident for those folks and that is that cap ex for 2008 in their plans for next year are as high as I have seen in a while.
TWST: And given the cost increases that obviously are being felt in raw materials, are they able to pass this through on the other side and maintain margins?
Mr. Dingmann: They are. Most of them right now are passing a lot of these costs on. I mean the services are getting hit with things like steel, they are getting hit with the fuel that they use to do this, but right now, they are still having pretty good luck passing most of that on, given how tight the market is for most of this equipment.
TWST: It sounds like a bright longer-term picture. What's the risk, what happens here if oil falls all the way to $80?
Mr. Dingmann: I think that's the risk, not as much on the offshore in large international plays. If you look at guys like BP (BP), Exxon (XOM), the large guys use such a low price deck number, that it would really take, as you said, probably a $80, $70 or lower type oil number really to change anything. You know probably where the risk would lie would be with some of that incremental demand, some of the smaller guys. Look at Chesapeake (CHK) talking about raising cap ex considerably. Guys like Aubrey McClendon at Chesapeake are quite a bit more nimble, so if you would see oil and gas sell off sufficiently, then you probably would have a good bit of that incremental demand back off, and that would pose a sort of a medium-term risk.
TWST: As you talk with investors at this point, given the volatility, what's the interest level in the space?
Mr. Dingmann: Definitely people are warming back up but there is still a bit of caution. The tone out there is still both of the commodities could drop a bit more. But at the same time I think a lot of the folks that I talk to, a lot of the larger clients, are looking at the longer-term picture, and most of them (and I would agree) still think it's quite good. So you are having guys thinking in on a longer-term basis and not necessarily playing this on a day-to-day, week-to-week basis.
TWST: Is this price volatility in oil and gas going to keep people on the sidelines for a while?
Mr. Dingmann: I think that's added to it. There is no question now that you have more of these ETFs such as the U.S. Oil (USO) where you can trade oil itself. I look at the non-commercial trading each day to see what these speculators are doing and there is no question that not just the direction, but the shear numbers are definitely up. If you would have asked me a couple of years ago or even a year ago, how much has speculation been basically pushing the prices, I would have said, relatively little and now my stance would be a bit different. I think it is somewhere in that middle ground. I don't necessarily think that's what dictates the direction, but it sure exacerbates which way that direction is going.
TWST: What are you telling investors to do at this point?
Mr. Dingmann: At this point there are just some companies that are, I think, entirely too cheap both on the E&P and oilfield service sides. It's always a bit easier to look at E&P when you are in a falling commodity environment because you can look at and see what the pure assets of the companies are worth on the service side besides the drillers and sort of pricing out what each land rig would go for. It is very difficult to determine the asset value of say, a Halliburton (HAL) and Schlumberger and so that becomes a bit more difficult. But given the pent-up demand, especially international, but even the domestic, I am telling folks that there are opportunities especially in the services and in the E&Ps.
TWST: Who do you like on the services side?
Mr. Dingmann: Services side, one group that I like that seems to be out of favor and that I don't think gets enough respect are the seismic guys. Names that I look at would be an equipment company such as Bolt Technology (BOLT). These guys are the number one maker of guns for the offshore seismic vessels and, knowing that we're going to probably add 30% more vessels to the fleet over the next 18 months, it seems to me you are better off to buy the razor blade than buy the razor in this case. So I think a company like Bolt will do extremely well. Moving to onshore crews, I think a company like Dawson Geophysical (DWSN) should do extremely well. On their call just a week or so ago they said that of their 18 crews, they are booked well into next year and some even through next year. They have more visibility than they have ever seen. So I really think the seismic group is stacking up quite well. And to your point about the offshore area and the way that's ramping up, rather than play necessarily the drillers themselves, I think Dril-Quip (DRQ) that does deep wellheads and Acergy (ACGY) that performs EPCIC contracts offshore — both make a lot of sense. If not even more sense than the playing the drillers themselves.
TWST: So there are a couple of different ways of playing the space.
Mr. Dingmann: Yes, I believe either with seismic or offshore services. Others right now are still saying they like the US natural gas story, so then your play would be one of three things. It would be an onshore driller such as the Nabors or Patterson, or it would be a compression company such a BJ Services (BJS), or it would be a compression company like a small one that I cover called Natural Gas Services Group (NGS), which provides low horsepower compression.
TWST: Any names to worry about in the space?
Mr. Dingmann: I guess I am always a bit nervous on what I'd like to say on some of the higher flyers. When you look at some of these new shale plays, one that I cover, and it's not a new shale play, but it's a shale play dictated toward Barnett, I had downgraded Carrizo (CRZO) when it was around $60 and now it's around $45, $46 and as gas prices had come down materially, the stock prices came down with that. And probably even more dramatic, we've seen some of the newer shale plays, the guys focused around the Haynesville, the likes of Goodrich (GDP), the likes of Petrohawk (HK) or GMX Resources (GMXR) — those three in particular have all seen their values drop in half just since early July. So as much as we've seen the commodity fall, we've seen these stocks fall even more. So to me that's where you run still a bit of the risk behind something like that.
TWST: Why the sharp pullback in those names? Or were they just overdone?
Mr. Dingmann: I think one could say that they were overdone. Most of these hit their highs on July 2 — a lot of those were up over 200% year to date. So yes we have seen them come down, but they are still up 60%, 70% year to date, which is not bad by any standards.