As service companies gear up to report second-quarter earnings, they are expected to have plenty of good news. According to Mark Urness and John Marrin, analysts with Calyon Securities (USA) Inc., aggregate second-quarter earnings are estimated to be up 13% on a sequential basis and 102% year-over-year. This comes as little surprise after a quarter of continued incessant rig activity, record-high prices, strong utilization rates and share repurchases. The analysts also expect some earnings surprises in the coming weeks from service companies such as Weatherford International, Baker Hughes, Schlumberger, Grant Prideco and Cameron International. "The factors driving earnings momentum in the oil-services sector remain firmly in place, and we believe there is potential for a number of upside earnings surprises," Urness and Marrin say. "We see Weatherford as having the best opportunity to beat the consensus estimate. Baker Hughes and Schlumberger may also out perform expectations, thanks to their strong exposure to international and offshore markets. Among the midcaps, we view Grant Prideco and Cameron as most likely to exceed consensus estimates." Earnings-per-share growth is expected to increase 13% sequentially and 102% year-over-year, primarily supported by gains in the offshore segment. "In our view, most of the sequential growth will be driven by the large caps, which should benefit from their Eastern Hemisphere exposure, as well as ongoing strength in the U.S. land drilling markets, where a rise in unconventional drilling activity continues to fuel demand for advanced drilling technologies," Urness and Marrin say. They do not expect midcap oil-service providers to perform as well as the large caps, partially due to earnings-per-share decline at BJ Services and flat results from Grant Prideco and Smith International. They expect strong earnings-per-share results from Cameron International and FMC Technologies, due to the strength of the subsea markets and surging backlogs. The land drillers are expected to have a solid second-quarter performance, led by Bronco Drilling and Nabors Industries, which are expected to record a 21% sequential increase and a 76% year-over-year increase, respectively. "We believe strength in the U.S. rig markets in second-quarter 2006 augurs well for Bronco Drilling, which continued to execute on its rig refurbishment program and expand capacity during the quarter," Urness and Marrin say. "With roughly half of [Nabors'] rigs on term contracts, we are looking for some modest daily cash margin compression in the period, as operating costs rise slightly faster than dayrates." The offshore drillers are also expected to have a good reporting season, thanks to high rig dayrates caused by supply shortages. The analysts expect the group to post a 29% sequential and a 175% year-over-year increase in earnings per share for the second quarter. Though companies' earnings per share remain high, stock prices in the sector continue to experience volatility. "The tug-of-war between the bulls and bears has grown intense, with the bulls looking at the impressive cash flow growth and strong balance sheets throughout the sector, while the bears emphasize significant uncertainties regarding commodity prices and the health of the U.S. economy," Urness and Marrin say. The three best-performing stocks in the sector for the second quarter were FMC Technologies (up 31.7%), McDermott International (up 25.3%) and Baker Hughes (up 19.7%). All three companies benefited from strong upward earnings revisions during the quarter, the analysts say. The laggards of the group in terms of stock performance were the drillers. As a group, the land drillers declined 6.8% in the second quarter, led by Bronco Drilling, which saw its share price drop 20.6%. The offshore drillers declined 5.6%, led by Rowan Cos. and Ensco International, which saw their stock prices drop 19% and 10.6%, respectively. Noble Corp. rounded out the three worst-performing stocks with an 8.2% decline, the analysts say. Management commentary during this reporting cycle is expected to focus on drivers supporting the current upcycle, including progress on organic growth, plans for free cash flow, cost inflation and supply/demand fundamentals in the drilling markets. The analysts believe the current upcycle will not peak until 2008 and a strong pricing environment remains in place. Rig activity continued to be solid through the second quarter, as well. Despite Canadian rig activity experiencing its normal seasonal decline, dropping 57.6% sequentially, activity remained up 17% year-over-year, Urness and Marrin say. As the third quarter marches on, the analysts note oil-service valuations are currently at compelling levels. "Oil and natural gas demand remains strong, and the world has very little spare oil productive capacity," Urness and Marrin say. "Despite large increases in the rig count over the past three years, there has been very little or no spare production capacity added. We believe industry contractual commitments continue to point to a period of strong growth for several more years. We believe it is way too premature for the market to be discounting the end of the cycle."