The roller coaster-like moves in the energy sector appear to be
ending. Energy prices are no longer too low to spur the development
of oil and gas fields. And they're not so high that they will choke
off demand for the world's largest energy consumers. With an
outlook for more stable energy prices in 2010, you can look for
more positive results from the companies that provide all kinds of
services and equipment to the global oil companies.
Company Name (Ticker)
Many investors tend to focus on the industry titans such as
. They ought to pay closer attention to
Weatherford International (
, a mid-cap player that sports strong growth prospects thanks to
recent contract wins.
If you simply look at the North American energy market, you'd see
little reason to be optimistic. Natural gas prices remain weak and
so many new gas fields have recently been discovered that another
spike is very unlikely. Weatherford is feeling this hit as much as
any player: Operating income in North America is likely to be just
$250 million to $300 million in 2010, well below the $1.2 billion
generated in 2008. Yet in the years to come, spending on natural
gas fields should rebound as existing fields become depleted,
supply shrinks and untapped wells get pulled into service. (Betting
on natural gas when prices are weak can certainly pay off: Amy
Calistri is up +650% this way.)
More importantly, Weatherford is also heavily exposed to the oil
exploration market, which is in the early stages of a rebound --
especially on the international stage. As a result, Weatherford is
poised to see a sharp acceleration in profits. The company is just
now ramping up in Iraq, Russia, Brazil, Saudi Arabia, Libya, China
Earlier in the decade, Weatherford wouldn't have been mentioned in
the same breath as the biggest industry players -- it had a limited
set of products and services to offer customers. But an acquisition
of Precision Drilling in 2005 and a purchase of
TNK division in 2009 has turned Weatherford into a full-service
shop . Precision brought the company expertise in the area of oil
and gas well drilling, while TNK had considerable exposure to the
burgeoning Russian energy market. These deals have fueled an
impressive string of new contract signings.
Trouble is, those new deals are still in various stages of
development, so the company's recent fourth-quarter earnings report
was a grab bag of slipped deadlines. Projects that should have
showed substantial progress in the fourth quarter are just getting
started. The company has sought to clear the decks by taking a
series of one-time charges that pushed fourth-quarter operating
results into the red.
To be sure, 2010 still represents a bit of a challenge: Weatherford
is highly-exposed to the Mexican market, which is characterized by
rapidly aging oil fields. Revenues from the region are falling, but
the remaining contracts carry better profit margins that the
contracts that have recently expired. So Mexican-derived revenues
are likely to fall, but profits should fare better.
Here in the United States, it will likely be several more quarters
before the imbalance between supply and demand for natural gas
comes into balance. When that happens, drilling activity should
begin a multi-year rebound and should help quarterly profits to
move from roughly $0.10 a share in the current quarter, to the
$0.30 to $0.40 range by the fourth quarter.
The stage could be set for a more robust 2011, when profit margins
should rebound toward recent peaks. During the last five years,
Weatherford's EBIT (earnings before interest and taxes) averaged
18%. A lot of the company's equipment sat idle in 2009, and it fell
to just 9%. This is a very capital-intensive business, and margins
can swing sharply if demand slumps even moderately. Yet EBIT
margins should rise steadily through 2010 as all of that dormant
equipment gets put back to work.
Why the brightening outlook? Weatherford acquired BP's stake in TNK
to gain greater access to the Russian energy market. Management
concedes that it has been a challenge to integrate TNK into its
operations, but expects to post strong results from that unit in
2011. In addition, the company has already secured more than $400
million in contracts in Iraq to help the country rebuild its energy
infrastructure. Lastly, energy exploration efforts in a range of
other countries are expected to rebound in coming quarters, unless
we see another precipitous plunge in global energy prices.
Despite Weatherford's promising outlook, most investors are
squarely focused on the present, leaving the stock price stuck in
the mid-teens. As investors start to look beyond the near-term
noise, shares should again start to merit a P/E ratio closer to 20
, which is a typical valuation in the early stage of the energy
exploration cycle for these companies. Weatherford looks set to
earn $1.25 to $1.50 a share in 2011 , which means the shares trade
for 10 to 13 times projected 2011 profits.
As the accompanying table shows, shares of Weatherford have the
lowest projected P/E ratio in the group, even as earnings are
expected to accelerate.
If Weatherford's P/E rises back to 20, then shares could hit $25
to $30 as the industry truly enters an upturn.
-- David Sterman
Disclosure: David Sterman does not own shares of any security
mentioned in this article.
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