Turkey of the week: take profits on this oil services stock

18.01.2008

by Paul Hill

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Crude oil is at around $100 a barrel and explorers are ramping up capital spending, so it’s no surprise that the oil-services sector is going gangbusters. And this stock is a particularly good example of how well the sector's being performing of late:

Wellstream (WSM), rated ADD by Evolution Securities

Wellstream is a manufacturer of flexible pipes used to transport oil from sub-sea wells to off-shore floating platforms. Since listing nine months ago at 320p, the price has rocketed nearly fourfold to over £11.

Its hoses are used by oil majors such as Chevron, Petrobas, Anadarko Petroleum and Devon Energy, and tend to be more versatile than their rigid counterparts. And at last week’s pre-close trading update, Wellstream said its “results are expected to be significantly ahead of analysts’ expectations” – with turnover set to soar from £50m in 2004 to over £250m in 2007. 

The order book has also shot up, rising 45% to £330m from £227m a year ago. This has triggered a new £35m investment to boost capacity at its UK and Brazilian factories. This demand is set to continue (albeit at a slightly lower clip) with research analysts Douglas Westwood forecasting the global flexible pipe market to grow from £1.1bn in 2006 to £1.9bn by 2011 – giving an average growth rate of 11.5% a year.

Finally, Wellstream, with a 26% share, is one of only three suppliers of flexible hoses in the world – the others being France’s Technip (60%) and NKT Flexible (14%). So not only have all three vendors benefited from stampeding growth, but they have also been able to hike selling prices. Indeed, Wellstream’s prices from its Newcastle site have shot up nearly 80% since 2004 to around £800 per metre.

So with results at record levels, why do I advise taking profits? Firstly, I believe the stock – trading on high-octane p/e ratios of 35 and 25 for 2007 and 2008 – is priced to perfection. As a value investor, this type of red-hot rating makes me cautious, especially when sector leader, Technip, is only valued on a 19 times p/e.  

Also, Wellstream is still reliant on a few large clients. If these relationships ever deteriorated, it could materially damage prospects. Lastly, much of the buoyancy for its niche off-shore technology is driven largely by surging oil prices. If crude went into reverse – perhaps due to a recession – then the economics supporting deep-sea exploration would diminish. 

So with the share price already in the stratosphere, I think there is far more downside risk than upside potential for investors. I suspect it is only a matter of time before other competitors enter this lucrative sector – bringing this stock crashing down to earth. One other potential catalyst for a de-rating could be if Candover, a private-equity house and large shareholder, decided to off-load its 14% stake.

Recommendation: TAKE PROFITS at 1,130p (market cap £1.12bn)

Paul Hill also runs a highly successful share-tipping service; click here to find out more: Precision Guided Investments.

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