Last week, as earnings season began, I suggested a few plays that, at the time looked a little risky. I mentioned four stocks as possibilities, Halcyon (HK), Exco (XCO), Continental (CLR) and Devon (DVN). The first two looked viable on the basis that all of the bad news about earnings was priced in, and the others were a play on the possibility of acquisition rumors. The takeover scenario hasn’t played out yet, but a reaction to slightly higher oil and some early “not as bad as it could have been” Q1 earnings in the energy sector have given all four a boost. They are all trading higher (between 3.5 and 13 percent higher) than Friday’s close.
So far, so good, but if those plays were a little too risky for your taste there may be a couple of trades in front of next week’s earnings releases that pose a little less risk. For that, rather than looking at extremely hard hit E&P companies, it may be better to look at oilfield services companies. They too have been under pressure as the E&P companies have shelved projects, but they have not hesitated to take action that has been welcomed by the market.
Big job cuts and other cost cutting measures have already been announced by almost all service companies. That may make it seem like a strange time to buy the stock going into earnings, but we are way past the point where shrinking capacity is a negative. For evidence, think about what happened to Schlumberger (SLB) stock on Thursday after the market close.
SLB released results that will set the pattern for oilfield service companies over the next couple of weeks. They missed expectations for revenue, but beat on the bottom line. At the same time they announced another 11,000 job cuts on top of the 9,000 already announced, taking the total to around 15 percent of the workforce, and lowered guidance for next year. Normally that combination would cause any stock to tank. SLB was up over 2 percent in aftermarket trading.
There is just so much bad news baked into both the estimates for anybody associated with energy, and the price of their stock, that any glimmer of good news will prompt buying. Less business, shrinking the company, and downgrading guidance were ignored in the case of SLB. A beat of drastically lowered estimates was enough to support the stock. I have said it many times and will say it again... Take it from somebody with 20 years of dealing room experience, market dynamics and positioning will always trump logic.
Those things make a positive reaction to earnings, whatever they are, more likely, while limiting the downside. That is why going into Q1 earnings long Halliburton (HAL) and the smaller Helix (HLX) who will both report on Monday constitutes a low risk trade. Neither company is likely to offer results that impress, but they don’t need to. Simply avoiding total disaster will cause a jump in the stock.
Obviously, buying on “not as bad as it could have been” is not usually a long term strategy. In this case, however, it may provide a useful entry point for a long term position. Nobody really expects oil companies to reduce drilling forever, and recovery in the industry will come. If HAL and HLX do open up higher on Tuesday it will enable investors to set stop losses that offer great protection, but some flexibility, and establish a position to take advantage of that trend as it develops.
Risk is a funny thing. Sometimes what looks like an extremely risky play is, on further analysis, not that risky. That is the case with this trade. Buying two under pressure oilfield service companies on the eve of their earnings releases sounds crazy at first, but in reality it offers a good upside with a limited downside, the very definition of a low risk trade.