Investors looking at energy stocks may have a bit of whiplash
these days. Oil prices appear fairly firm while natural gas prices
still remain near multi-year lows. In other countries, natural gas
prices are surging, as demand rises in places that have
de-commissioned nuclear power plants, such as Japan and Germany.
Here at StreetAuthority, we take a much broader view of oil, gas,
coal, nuclear and many other commodities. Many of us remain focused
on the multi-decade trend that is playing out before our eyes.
Demand for energy and other commodities -- in all forms -- is in a
long-term uptrend, even as supplies remain constant. Over time,
we'll see periods of scarcity that ignite a powerful rally in
prices. And it's crucial to keep identifying the
commodity
producers that will be perfectly positioned for the next boom.
Yet here in the spring of 2012, it's a bit hard to see that
long-term trend in action. Many commodities are falling from their
peaks as European economic concerns weigh heavily. As an example,
my focus on
Marathon Oil (NYSE:
MRO
)
in my
$100,000 Real-Money Portfolio
a few months ago was premature, and
shares
are underwater at the moment. Oil and natural gas prices have
fallen since mid-winter, and they could even fall a bit more before
the eventual inevitable rebound comes.
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Perhaps this is a good time to focus away from oil and gas stocks
and toward the companies that simply provide the products and
services that energy drillers need. Yet if you hear from the
industry's biggest players like
Schlumberger (NYSE:
SLB
)
and
Halliburton (NYSE:
HAL
)
, they'll tell you that all of the global cross-currents are
creating a mixed picture for them right now as well. On recent
conference calls, both of these firms conceded that the customers
(energy drillers) are calling the shots right now. So price
concessions are essential if they want to win contracts.
But at least one industry player is bucking that trend. It focuses
on a certain niche that is seeing strong demand -- and strong
pricing. And that sets the stage for solid results in the quarters
to come.
From gas to oil
By now, everyone knows about "fracking" (or hydraulic fracturing
wells), which has been able to tap hard-to-reach shale formations.
But a problem has emerged. Many fracked wells need some help when
it comes time to harvest oil along with the gas. Sometimes heavy
oil just wants to stay put and needs to be coaxed up to the surface
by other means. That's where "artificial lift" comes in. This
technique involves a range of other technologies (from the
insertion of a mechanical pump inside the well to the injection of
various gases into the well) to boost pressure.
At the risk of over-simplifying, fracking is used to tap a fresh
well to get the natural gas to come to the surface. Artificial lift
is used later on the same well when harder-to-tap oil is brought
up. Because of this, artificial lift producers are more beholden to
oil prices (which are still reasonably strong), and not the
struggling natural gas
market
.
One of the leading providers of artificial lift systems:
Weatherford Industries (NYSE:
WFT
)
. This company controls one-third of the domestic artificial lift
market, and the technology is one of Weatherford's most profitable
lines of business.
And it's about to get even more profitable.
As analysts at JP Morgan recently noted, "the artificial lift
market is just now gaining pricing traction, as almost every
completed oil well will require some type of artificial lift."
We're talking about nearly 1,400 oil wells now in service, up more
than 40% from a year ago.
The Downside Protection -->
After falling more than 40% from the
52-week high
, this is a very inexpensive stock, trading at just 7.5 times
consensus 2013
profit
forecasts of around $1.70 a share. Rival Schlumberger's 2013
multiple is around 12, while
Baker Hughes (NYSE:
BHI
)
trades for about 9.5 times projected profits. Yet Weatherford is
actually the best-positioned, thanks to that high degree of
exposure to artificial lift technology. Schlumberger and Baker
Hughes are more tightly focused on the moribund gas fracking
market. Said another way, Weatherford's 7.5 times forward multiple
is at a 45% discount to where it has historically traded at during
the past five years.
Why is this stock so cheap? It's because Weatherford still derives
more than half of its revenue (though less than half of its
profits) from foreign markets. And outside the United States,
energy producers have the upper hand on pricing, and the company's
foreign profits are likely to be flat -- at best -- this year. Yet
Weatherford's foreign results will have a silver lining. The
company had entered into a series of poorly-priced contracts a few
years ago that are now expiring, and management is convinced that
contract renewals will
yield
much better profitability. This is one oil services company that
will actually have a better story to tell in its foreign sales
division.
Another boost: industry pricing pressures are most pronounced in
offshore drilling projects off the coast of Africa and Brazil.
Weatherford is mostly focused on land-based drilling, which has not
seen the same level of pricing pressures.
Shares are also inexpensive because Weatherford delivered the
embarrassing news this past winter that it didn't calculate its
global tax liabilities accurately. That led some investors to think
that the management team is "the gang that couldn't shoot
straight," but Weatherford has more recently significantly beefed
up its financial controls.
Upside Triggers -->
This stock is a story about profit margins. In recent years,
Weatherford had too much capacity, and its under-utilized gear and
overhead
created a drag on margins. As sales grow, expenses are likely to
remain in check, allowing margins to expand. The expected strength
in the high-margin artificial lift segment should help Weatherford
post some of the most impressive
margin
gains in the industry in coming quarters. Weatherford's
EBITDA
margins were slightly below 20% in 2010 and just above 20% in 2011.
This year, they are on track to hit 23%, and they could approach
25% by 2013. That helps explain why analysts see
EPS
(
earnings
per share) growing at a steady 30% pace.
Action to Take -->
Unlike most of my other picks in my
$100,000 Real-Money Portfolio
, I view Weatherford more as a trade than an investment. This isn't
a play on a multi-year cycle, but instead on the rest of 2012 (and
perhaps some of 2013) playing out more robustly than the dowdy
share price indicates.
48 hours after you read this, I will be making a pair of moves in
my portfolio. First, I will be taking advantage of the recent
market weakness to sell 300 shares (or one-half) of my position in
the
Direxion Daily Small CapBear 3X Shares ETF (NYSE:
TZA
)
. At the same time, I will buy 500 shares (worth roughly $6,100 at
current prices) of Weatherford Industries. I also suggest investors
put in a stop loss at $10, though as I recently noted, I will not
be deploying the stop-loss limits myself. Shares can be bought
under $15.
All prices are as of Thursday, May 17.
|
|
Security (Ticker)
|
Shares
|
Initial Purchase Date
|
Avg.
Purchase Price
|
Recent Price
|
Current Value
|
Buy Under
|
Target
|
Total Return
|
| Ford Motor (
F
) |
1,090 |
01/04/12 |
$11.44 |
$10.11 |
$11,014 |
$13 |
$20 |
-11.7%
|
| Alcoa (
AA
) |
500 |
01/06/12 |
$9.32 |
$8.45 |
$4,226 |
$12 |
$16 |
-9.7%
|
| Cree (
CREE
) |
300 |
01/12/12 |
$23.22 |
$30.01 |
$9,003 |
$25 |
$40 |
29.1%
|
| Exide (
XIDE
) |
1,500 |
02/01/12 |
$3.41 |
$2.32 |
$3,480 |
N/A |
N/A |
-32.1%
|
| Citigroup (
C
) |
300 |
02/06/12 |
$33.28 |
$26.84 |
$8,052 |
$36 |
$50 |
-19.4%
|
| Ligand Pharma (LGND) |
350 |
02/13/12 |
$14.87 |
$11.71 |
$4,099 |
$17 |
$30 |
-21.2%
|
| Marathon Oil (MRO) |
200 |
02/24/12 |
$35.01 |
$24.34 |
$4,868 |
$40 |
N/A |
-30.5%
|
| Direxion Small Cap (TZA) |
600 |
02/29/12 |
$18.42 |
$22.24 |
$13,344 |
N/A |
N/A |
20.6%
|
| Calgon Carbon(CCC) |
400 |
03/14/12 |
$15.38 |
$13.30 |
$5,320 |
N/A |
N/A |
-13.7%
|
| Echelon (ELON) |
1,000 |
03/30/12 |
$4.51 |
$3.47 |
$3,471 |
$7 |
N/A |
-23.1%
|
| MDC Partners (MDCA) |
500 |
04/09/12 |
$10.57 |
$9.60 |
$4,800 |
N/A |
N/A |
-9.4%
|
| Freeport-McMoran (FCX) |
200 |
04/24/12 |
$37.00 |
$32.45 |
$6,489 |
N/A |
N/A |
-12.4%
|
| Zoltek (ZOLT) |
600 |
05/11/12 |
$9.16 |
$8.31 |
$4,986 |
$11 |
N/A |
-9.4%
|
| |
| |
Security
Holdings |
$83,152 |
|
|
|
|
| |
$ Cash
Holdings |
$6,155 |
|
|
|
| |
Total
Return since January 2012* |
$89,307 |
|
|
-10.7%
|
* Individual security
returns are shown as of the date each security was
added to this portfolio. However, total returns for
the portfolio and the S&P are listed since the
portfolio was funded with $100,000 of real money on
Jan. 4, 2012.
Visit this link
to view a listing of all previously-closed
$100,000 Real-Money Portfolio
holdings. |
|
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of TZA, MRO in one or more if its "real money"
portfolios.