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Americas: Energy: Oil Services - Drilling:
Even the best land rigs will suffer; HP to Sell
from Neutral
Industry context
We are downgrading HP to Sell from Neutral with a 6 month price target of $20,
representing 15% potential downside. Meetings with E&Ps in Houston left us even more
bearish on the US land drilling market. The land rig count is likely to fall to just under 880
over the coming months and meander until natural gas prices hold above $5 – a 2H2009
event in our view. Thus, we expect the land drillers to be range bound with a downward
bias in the near-term. We prefer E&Ps as a way to play a rebound in natural gas prices and
expect them to react sooner to an improvement in the natural gas supply/demand balance.
We see three reasons why the land rig count is not lower: (1) E&P’s are honoring land rig
contracts but plan to release them at expiration; (2) Many E&Ps have hedges in place that
prop up near-term cash flow; and (3) Much of the drilling is related to the desire to hold
acreage. We expect HP to be disproportionally impacted as the first two reasons come to
an end.
US land rig count to trough just below 880; lowering estimates
We are lowering our US land rig count forecast to reflect a 44% yoy decline in 2009 and
expect it average 883 rigs in 2Q2009 (a 54% peak to trough decline).  We are lowering
our EPS estimates for the land drillers by 11%/65% on average for 2009/2010; however,
this translates into a 6%/11% decline in EBITDA. We are also lowering our price targets
by 5% on average.
HP is discounting an overly optimistic scenario
HP is discounting an overly optimistic scenario in our view given the poor outlook for US
land drilling activity. We expect HP’s rig count to fall by a greater degree than expected
as contracts expire and horizontal rigs are dropped. Investors are also overestimating HP’s
ability to maintain margins in the current downcycle, in our view. There is little doubt that
HP will emerge as the market share winner; however, we expect the margin premium to
peers to contract as the company competes for utilization in a lower rig count
environment. We are 24% below consensus EPS in 2010. We lowered our six month price
target for HP to $20 from $21. The stock appears to be discounting long-term dayrates of
$20,000 (or $12-$13 million per rig) which is above with our dayrate forecast. Valuation
multiples are also at a historically high premium to the DW drillers.
The Goldman Sachs Group Inc. does and seeks to do business with companies covered in
its research reports. As a result, investors should be aware that the firm may have a
conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making their investment
decision.
March 13, 2009 Analyst Comment
2 Goldman Sachs Global Investment Research