Markets & Finance

Well-Positioned for Growth


By Tina Vital With a U.S.-led economic rebound in its early stages, S&P believes that worldwide demand for oil and gas will grow by 2-3% per year over the next 10 years. But where will the hydrocarbons come from? Industry sources estimate that more than half of current oil and gas production will need to be replaced to meet this demand.

That means energy producers will have to make heavy investments in exploration and production -- and that should provide a boost to the earnings of oilfield services company Weatherford International (WFT).

The current incarnation of the company dates back to 1998, when Energy Ventures acquired Weatherford Enterra. The new company rationalized its assets and spun off its capital-intensive tubular and compression businesses. The pairing has achieved impressive growth -- sales have climbed 71% to $2.3 billion -- and Weatherford has become one of the largest oilfield service companies in the world. It provides products and services used in sophisticated drilling (58% of 2001 revenues; 75% of 2001 total business segment income), well completion (15%; 6%), and production (26%; 19%) for companies that explore for and produce oil and natural gas.

TECHNOLOGY BOOST. While the energy industry is characterized by long business cycles, Weatherford has identified some trends within the sector that have provided the basis for businesses with growth rates higher than the overall industry. Certain of these trends -- the aging of reservoirs and the diminishing size of new discoveries -- appear to have changed the economies of scale in exploration and production, forcing producers to cut costs to maintain their profits. Weatherford is focused on acquiring the necessary technology to take advantage of these secular trends and resultant need by producers to reduce their costs.

The company's drilling and intervention services segment provides technology to develop and extend the life of a well. Its basic business (drilling products, downhole services and well installation) has been leveraged by various new technologies (underbalanced services, drilling with casing, extended reach, and multilaterals). Underbalanced, or UB, drilling eliminates the formation of well formation damage (called "skin"), common in conventional activities, by drilling with a column of fluid that exerts less pressure at the bit than the reservoir pressure. This creates a pressure gradient from which the hydrocarbons will flow up to the surface.

While conventional and UB drilling costs are comparable, UB may be advantageous in development wells, where the drilling continues for long periods; and depleting wells, where "skin" damage is greater. Weatherford is the leader (with about a 50% market share) in the emerging market for UB drilling (about 2% of all oil and gas wells drilled worldwide), which the company estimates may grow to 30% of all oil and gas well drilled within five years.

The Completion Systems operation provides a wide range of proprietary technologies, which go "downhole" to maximize the production of oil and natural gas. Products include intelligent well, expandable sand screens (ESS), fiber optic sensors, and flow and sand control.

GROWING MARKETS. Intelligent well completion is in the early stages of development; its future is linked to growing deepwater drilling efforts - as its use in high-end deepwater critical wells avoids the need for expensive work-overs.

Expandables were developed by Shell Oil about 15 years ago, but Weatherford's Petroline unit commercialized Shell's technology for sand control applications -- and in 1999, Petroline introduced ESS as an alternative to the conventional use of the expensive "gravel packing" approach to maintain the support structure of the well formation during drilling. Weatherford and Halliburton are the leaders in the emerging market for ESS, which the company estimates will grow to $3-4 billion within five to ten years. Its ESS revenues have grown from $15 million in 2000, to $55 million in 2001; and should reach $100 million in 2002.

Artificial lifts (or pumps) are installed in wells that do not have sufficient pressure to raise the oil to the surface. Weatherford offers all forms of artificial lifts used in oil and gas production, as well as production optimization and field management. It is the leader (about 40% share) in the approximate 100,000 oil well market, which the company estimates will grow at about 100% annually over the next five years.

ON THE REBOUND. The U.S. economy is looking stronger, and S&P estimates that U.S. real GDP will grow 2.7% in 2002 and 3.7% in 2003 -- which should boost the demand for energy. Oil prices, as measured by the benchmark West Texas Intermediate grade of crude, continue to firm around $25 per barrel, and the rollover of OPEC production cuts at the cartel's meeting on Mar. 15, and promises of cooperation from non-OPEC producers, should continue to stabilize prices. Energy research outfit DRI-WEFA projects 2002 world oil demand will remain near 2001 levels.

Further, we expect U.S. natural gas drilling will rebound in the second half of 2002. According to DRI-WEFA, U.S. natural gas demand will rise 3.0% in 2002, to 22.66 trillion cubic feet; however, U.S. dry gas production is projected to decline 3.8% because of cuts in gas-directed drilling and rising depletion rates. As a result, the economic recovery is likely to cause a sharp increase in U.S. natural gas prices in late 2002 or early 2003.

With about half of its revenues derived from foreign markets and expanded opportunities based on its new technologies, Weatherford is well-positioned to benefit from a rebound in drilling activity in the U.S. and international markets. S&P projects earnings per share to rise to $2.38 in 2003 from the $1.81 we expect for 2002.

The shares trade at a current enterprise value-to-EBITDA ratio of 11.9, above a peer average of 10.5. However, the stock is trading at only 8.8 times our 2003 EBITDA estimate, at a significant discount to a 3-year historical peer average of 15.5 times EBITDA. Therefore, we believe our 12-month target price of $60, which implies an upside potential of 30% from the Mar. 22, 2002, closing price of $46, may be conservative. Analyst Vital covers oil & gas stocks for Standard & Poor's


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