Components for oil drilling and fracking

● Our view in a nutshell: Schoeller-Bleckmann Oilfield Equipment (SBO) is a financially sound pure-play manufacturer of components used in the drilling and fracking of oil and gas wells. A high reliance on the North American shale sector, which collapsed in 2015/16, resulted in a drastic decline in sales (-42% yoy in FY 2016), and profitability. SBO responded rapidly with a 40% capacity decrease and by integrating vertically into well preparation for fracking, a segment that has developed very strongly over the past few months. While SBO’s operations are set up to benefit from the market revival, we remain concerned about the scale of such recovery and the pricing environment.

● Recent trends and outlook: SBO’s Q3 results show a strong revival of orders (EUR91m, +120% yoy), driven by the recovery in North American shale drilling. Sales of EUR92m (+104% yoy) were led by the Oilfield Equipment division (drilling motors, the M&A effect, fracking), while the business with high-precision drill components is still struggling. The EBITA of EUR13m (13.8% margin) confirms that the operational turnaround has been achieved, while the net result (-EUR80m) is distorted by a EUR91m revaluation loss relating to the purchase of the remaining shares of Downhole Tech (acquired in April 2016). While this indicates improved profitability of Schoeller’s US fracking activities, it raises questions about the implied multiples that management agreed to pay for the business. While SBO does not provide a financial outlook, management “takes a positive look” on 2018.

● Key questions for management: Fracking seems to be a cost-effective substitute for new (expensive) drilling. How does SBO benefit from this trend? Will SBO seek more M&A in well-preparation and what percentage of group sales can this business account for by 2020? What is the new- normal for NAFTA shale drilling activity (today 1,110 rigs) with an oil price of USD60/bbl?

● Valuation, and where we differ from consensus: While the recovery in global drilling activity could re-accelerate, this will require a far higher oil price. We acknowledge the strong order growth for drill components since Q4 2016, but believe that this was driven by restocking and expect growth to soften in Q4 2017. We believe the share is overvalued, trading at a 2019E P/E (adjusted) of 29.0x and a 2019E EV/EBITA (adjusted) of 19.5x, considerably more expensive than our mid-cap coverage (21.3x and 14.6x respectively). This is also reflected in our DCF-derived price target of EUR41.00, which is 52% below the current share price.