We are downgrading our recommendation on Smith International (SII) shares to Underperform. We expect Smith’s earnings to remain under pressure in 2010 due to continued erosion in volumes and pricing in North America, and to a lesser extent, internationally. The North American service sector’s leverage to natural gas prices may significantly affect the company’s top line.
Smith’s weaker-than-expected third quarter results reflect a challenging North American natural gas market that contributed to continued pricing pressure within the domestic operations of the Distribution and the Oilfield segments.
However, some of these, if not all, were offset by the company’s PathFinder business and contribution from the M-I SWACO joint venture.
Smith guided towards an increase in M-I SWACO revenue in 2010, driven by a growing number of deepwater rigs and the commercialization of new technologies.
We have long liked Smith International, given its well-run operations and cyclical leverage. However, the investors’ comfort with the stock changed with last year’s W-H Energy acquisition, which has exhibited a materially different strategic outlook that has burdened returns in the interim for growth prospects.
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