Almost Every Oil Well Will Need This Company's Technology

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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.


 
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.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Stocks

Referenced Stocks: AA , C , CREE , F , XIDE

David Sterman

David Sterman

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