After plunging steadily in recent weeks, share prices in the oil
and gas exploration appear to have finally found a floor. Some
stocks such as
sharply rose on Wednesday after falling close to their 52-week
lows, while other stocks such as
Diamond Offshore (
Pride International (
are still in the doldrums. Their relative levels of exposure to the
Gulf Coast explains why the stock charts are diverging.
A Quick Primer
To get a sense of the future direction of these stocks, you need to
step back and assess both geographic and technical considerations.
To be sure, the massive sell-off, which has eroded -30% to -40% of
the value of some of these companies, is far out of proportion to
their exposure to the Gulf Coast. Companies that provide equipment
and services for oil and gas drillers in the Gulf include Diamond
ENSCO International (
Noble Corporation (
, Pride International,
Rowan Companies (
Seahawk Drilling (Nasdaq: HAWK)
Most of these firms derive the majority of sales through the lease
of drilling rigs. Some have greater exposure to shallow water rigs
(which are likely to be less impacted by further government action)
while others have greater exposure to deep-water rigs. This is the
area receiving a great deal of scrutiny, as deep-water drilling
takes place under extremely high pressures (which can reach 30,000
pounds per square inch).
Even though Transocean is closely associated with the current
massive oil and gas leak, it actually derives only a small portion
of revenue in the Gulf Coast. Most of its equipment and services
are used in other international markets. That's also the case with
Pride International. In contrast, firms such as Noble and Diamond
Offshore have a much higher degree of exposure to Gulf Coast
drilling. That helps explain why shares of Pride International are
off -20% during the past three months while Diamond and Noble are
off closer to -35% or -40%.
Action to Take -->
It might be tempting to buy up shares of Diamond and Noble, as they
are undeniably cheap based on historical cash flow rates, but we
simply don't know how any regulatory changes regarding drilling
will play out. A moratorium on new drilling activity in the Gulf
could last as little as three months or as long as two years. The
longer the spill continues, the longer the moratorium will likely
Instead, investors should look at shares of Pride International,
which are back down at 52-week lows and trade at half the price
they fetched in 2008, when the industry was in a growth phase.
Analysts expect Pride to sharply boost per-share profits above the
$3 mark next year, as expiring contracts are renewed on better
terms. Shares trade for around eight times projected 2011 profits
and six times projected 2011 earnings before interest, tax,
depreciation and amortization (EBITDA). As investors come to see
that Pride has much greater exposure to drilling markets such as
Latin America, Africa and the North Sea, those multiples should
rebound, and shares have some +50% upside back to their 52-week
Staying on Dry Land
Companies that offer drilling equipment and services to land-based
energy exploration firms have also been hit recently -- though to a
more moderate extent. Shares of
Helmerich & Payne (
Nabors Industries (
Patterson-UTI Energy (Nasdaq: PTEN)
have shed roughly -10% to -15% of their value during the past
month, though they will not be affected by any industry regulatory
Analysts have been lukewarm to this group, largely because low
natural gas prices have crimped drilling activity. But if the
output from the Gulf drops in coming quarters, supply will shrink
and gas prices will rise, which should spur an increase in
land-based drilling. As drilling activity increases, these firms
can charge more for their equipment, known in the industry as
Action to Take -->
Nabors, the industry's largest player, looks particularly
appealing, trading just above book value of $18 a share, and less
than four times EBITDA , on an enterprise value basis.
Year-over-year revenue comparisons have been negative for a number
of quarters as the number of land-based rigs in action steadily
declined over the last few years. But the number of rigs in service
has begun climbing again, according to
Baker Hughes (
, and analysts expect Nabors Industries to start posting positive
revenue comparisons beginning in the current quarter. Per-share
profits should bottom out at around $1 this year, and thanks to the
high degree of leverage in this earnings model, profits could rise
more than +50% next year on a +15% jump in revenue. Cash flow per
share could approach $4 next year.
The International Giants
Shares of the largest international oil services companies have
also been hit hard in recent weeks, though as noted earlier, showed
big gains on Wednesday. The sell-off seemed unwarranted. These
firms derive most of their revenue in other regions of the world,
and should see minimal impact from any slowdown in the Gulf coast.
Governments in Latin America, Asia and the Middle East will want to
know what caused
equipment to fail, but they are unlikely to slow the pace of
drilling activity. In fact, with their deep technical expertise,
these firms may actually benefit from an increased demand for
engineering services and safety equipment.
Schlumberger is the industry's largest player, offering a wide
array of services and equipment, and with shares not far from the
52-week low, they represent real value. Halliburton, the industry's
second leading player, also represents a solid play on the rapid
engineering advances taking place in energy exploration. But
investors may want to focus on
Weatherford International (
, which is arguably the least-understood and most compellingly
valued name in the group. Shares hit a 52-week low before
rebounding on Wednesday.
Earlier in the decade, Weatherford wouldn't have been mentioned in
the same breath as the biggest industry players, as it had a
limited set of products and services to offer customers. But a 2005
acquisition of Precision Drilling and a 2009 purchase of BP's TNK
division has turned Weatherford into a full-service shop. And that
has 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 earnings reports have been a
grab bag of slipped deadlines. The company has sought to clear the
decks by taking a series of one-time charges that led Weatherford
to miss estimates in each of the last two quarters.
As this year progresses, Weatherford expects to report cleaner
results and post rising revenue and profits. Why the brightening
outlook? As noted earlier, 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 is ramping up in Iraq, and has
already secured more than $400 million in contracts to help that
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.
Action to Take -->
Most investors are squarely focused on the present, so
Weatherford's stock price remains stuck in the mid-teens. As
investors start to look beyond the near-term noise, shares should
again start to merit a price-to-earnings ratio (P/E) closer to 20,
which is a typical P/E ratio in the early stage of the cycle for
these companies. Weatherford looks set to earn more than $1 a share
in 2011, and closer to $1.50 in 2012, which means shares could hit
$25 to $30 as the industry truly enters an upturn.
Exploration & Production Stocks Dragged Down by
The exploration & production (E&P) stocks have been
particularly hard hit as of late, especially those with a high
degree of exposure to Gulf Coast drilling.
Anadarko Petroleum (
for example, has fallen from $75 to $44 in just five weeks. More
than $10 billion has been erased from its market value . Anadarko
was involved in the current damaged well, and could be on the hook
for big lawsuits, but they are unlikely to reach even half the
amount of that lost market value.
That makes the stock a real value to those willing to shoulder the
risk that lawsuits could weigh on the stock for some time to come.
Analysts believe the value, of Anadarko's remaining oil fields, is
worth around $68 a share, roughly +50% above the current share
McMoran Exploration (
has seen its shares fall more than -40% in the last three months.
McMoran is focused exclusively on the Gulf, and will surely see a
hit to sales and profits from the drilling moratorium. But once the
moratorium is lifted, shares, which saw a solid pop on Wednesday,
could rise another +50% or more, back to their 52-week high. Value
investors will want to get in on this name before the moratorium is
Other E&P firms have been hit to a smaller degree, as they
don't have the same liability but will be similarly impacted by the
current drilling moratorium.
Devon Energy (
, for example, is off its highs set in January, but is always a
favorite of institutional investors thanks to the high quality of
its various oil and gas fields (almost all of which are land-based)
and management's very strong track record.
But value investors should take a closer look at
Southwest Energy (
, which has fallen nearly -15% in the past three months even though
it has no exposure to Gulf-based drilling.
Shares have been trading poorly due to weak natural gas prices. If
and when gas prices finally firm up, Southwestern Energy looks set
to generate considerable cash flow in 2011 and 2012. The company
has been digging hundreds of new wells in the Fayetteville, Ark.,
region, known as the Fayetteville Shale. That should lead to a +30%
jump in production this year, and another +30% spike in output next
Action to Take -->
Analysts tend to multiply projected gas prices by projected output,
and then subtract projected expenses to arrive at a forecast for
cash flow. Based on the current price curve and Southwestern's
stated output plans, the company is expected to generate around
$1.5 billion in cash flow this year, $2.2 billion in 2011 and $2.8
billion in 2012. Against that backdrop, shares trade at a sharp
discount to their historical average. During the past ten years,
which have seen all phases of the boom and bust cycle, shares have
typically traded for 8.6 times next year's cash flow. Now, they
trade for just five times projected 2011 cash flow. If shares can
climb back to that average multiple, then they possess more than
+50% upside from current levels.
-- David Sterman
Disclosure: David Sterman does not own shares of any security
mentioned in this article.
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