Energy-Services Companies: Drills and Bills

There's an old saw that says if you really want to strike gold, don't invest in the miners -- buy the pick and shovel makers instead. Apply the analogy to energy stocks and you come up with plenty of opportunity in oil-field service and equipment companies. These are the companies that provide drilling rigs, pressure valves, and other sundry equipment and services to energy exploration and production companies such as the Exxon Mobils and Chevrons of the world.

Analysts at Morgan Stanley are so bullish on the energy-service sector that on Monday, they raised earnings estimates and price targets for seven stocks, most notably Cameron International (symbol CAM, $47 as of Monday's close) and Schlumberger (SLB, $63.50), and earnings estimates alone for a couple more. The rationale: Demand for drilling-related services and technology looks good through 2011, and these companies will be able to hike prices more than was expected.

Things haven't looked this good for the energy-service sector since Studio 54 was the hot spot and movie marquees read Saturday Night Fever. In fact, these firms are posting their best operating revenues ever, according to the Value Line Investment Survey. It's a nearly perfect combination: Persistently high oil and gas prices (economists at Global Insight recently projected that oil prices would average $67 a barrel this year), coupled with surging worldwide consumption, led by Chinese demand. At the same time, the energy industry is finding itself ill-equipped after decades of underinvestment and under political pressure to put some of its windfall profits to work -- boosting prospects for spending on drilling and all that it entails. Indeed, oil and natural gas companies in the SP 500 index increased capital spending 66% in the first quarter of this year.

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Little wonder Morgan Stanley likes the group. Its analysts upgraded Cameron International from equal weight (hold) to overweight (buy) and said the stock could trade up to $75 a share over the next year or so, up from a previous target of $66 a share. Cameron makes pressure-control equipment used in drilling, production and transmission, both on- and off-shore, as well as undersea. The bulls at Morgan Stanley see earnings of $2.46 a share this year and $3.62 a share next year, compared with an average estimate of $2.40 this year and $3.20 next. Revenue growth could average 7% to 8% annually over the next five years, while prices could experience double-digit annual hikes.

Schlumberger will be a major beneficiary of a massive expansion under way in the offshore drilling rig fleet, and the company's focus on research and technology will stand it in good stead as the industry searches for energy reserves in obscure or unusual places. Morgan Stanley analysts predict that the stock will reach $100 a share in the coming months -- up from a previous target of $86. Although Morgan's 2006 earnings estimate is about in line with the average ($2.71 a share versus $2.67) the estimate for 2008 is far more bullish ($4.66 versus $4.14). But Schlumberger has other bulls behind it: Mad Money's manic Jim Cramer recently called the stock "ridiculously underpriced" and as of the first quarter, it was the top holding of respected fund manager Charles Ober, who runs the T. Rowe Price New Era Fund.

In its love-fest with energy-service stocks, Morgan Stanley also raised its target price and earnings estimates for Halliburton (HAL, $73), Baker Hughes International (BHI, $79), Weatherford International (WFT, $47), W-H Energy Services (WHQ, $50) and FMC Technologies (FTI, $68).