Over the earnings season it has become evident that the ‘Capex Compression’ theme that Douglas-Westwood first alerted the market to last year is playing out. A number of E&P companies have reported reduced earnings as a function of cost and consequently, have reduced or are being more selective on Capex projects. We see this as a positive for all stakeholders in the industry which has been in an upward cycle for five years, prompting high cost inflation across all categories of product, service and engineering provision which was always unsustainable and fostered inefficiency.
The impact for oil services will be twofold: firstly, reduced outlook on revenues for 2015 and secondly, immediate pressure from E&P to deliver cost reduction. Oil services revenue will remain on a growth trajectory over 2014 and earnings, subject to cost control and operational efficiency, should remain stable on the whole. This said, we expect that as projects are delayed and industry spending pauses for breath, backlog build and revenue visibility will decline. Sectors that have been highly constrained and out of balance are most likely at risk. Other market sectors where current supply levels are adequate and the risk of cost escalation or operational delays minimised will see sustained activity. In other words, it won’t impact everyone equally.
From a transactional perspective this presents a buy-side opportunity and sell-side risk. Valuations in the services sector have been growing to peak levels on the back of a historically buoyant market, levels in our view that are not sustainable for a cyclical industry. Calling the cycle is always fundamental in any investment decision but as 2014 unfolds, expectations of high valuations from sellers will have to alter. Understanding which sectors and organisations are going to be impacted and lose confidence, in addition to calling when the growth trajectory will kick in are the obvious questions. Our view is that there is an impending window. If you are not prepared you will miss it, as it may not last long.
Andrew Reid, Douglas-Westwood London
+44 1224 264970 or Andrew.Reid@douglaswestwood.com