In the oil services sector, corporate earning estimates are down in 2003 while stock valuations are moving up — the first signs of an uptick in the cycle, which will lead to meaningful increases in the next 12 months as natural gas prices rise, according to analyst Marshall Adkins in Raymond James’ Stat of the Week.

On the earnings side, said Adkins, “we have seen many oil service companies posting earnings per share on the low end of the consensus range, and have seen a number of downward earnings revisions in the early weeks of this reporting season. The earnings revisions are mostly a result of the fact that drilling rig activity has stalled since second-quarter levels, and speculation that a rig count will not start to improve until late in the fourth quarter or early next year. On the valuation side we have seen the stocks start to move up and multiples improve.”

The reason for the trend, said Adkins, is that the “underlying drivers of this industry (oil and gas prices) continue to “improve well ahead of activity and earnings. Stock prices tend to move with commodity prices on the expectations of better activity levels and earnings in the future.”

Specifically, he said, “the current commodity price environment, coupled with Raymond James’ outlook for strengthening natural gas prices going forward, will result in a significant increase in drilling activity.” Adkins noted that drilling activity typically lags natural gas prices by approximately six to nine months. He acknowledged that the most difficult part of forecasting as to when prices will rise is in the timing, and while many analysts “talk about an impending recovery, but are hesitate to model it.” Raymond James analysts are in the same boat, he added.

“The problem stems from the fact that earnings leverage is so great in this industry that missing the timing by a mere month or two can dramatically alter an entire year’s EPS forecast.” Therefore, Adkins said, near-term earnings projections become much more important.

Historically, price-to-earnings multiples “improve dramatically in relatively low earnings environments as the cycle bottoms,” said Adkins. “As such, we expect 2003 P/E multiples to improve sharply over the next few months as energy stock prices improve. Just as drilling activity levels lag natural gas prices, earnings should lag stock price moves.

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