Oil Services, Equipment Stocks To Watch As U.S. Shale Revives

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The oil industry has now taught a new generation of investors just how brutal its downturns can be, with the 18-month price collapse that began in June 2014. But the industry's recoveries can also be powerful affairs, often lasting years.

That fact has kept a large audience of investors closely tuned to the price recovery begun after oil scraped 13-year lows last February. With names as wide-ranging as Schlumberger ( SLB ), Baker Hughes ( BHI ), Fairmount Santrol Holdings ( FMSA ) and Nabors Industries ( NBR ) set for earnings rebounds, when to pull the trigger and where to jump in are just two among many questions investors asked as the price of West Texas Intermediate oil climbed to a peak early this year.

Prices have since held steady near their best level since July 2015. WTI ended the past week up more than 100% from year-ago lows, but still 50% below highs marked just before the onset of the global oil glut in 2014.

Worries that recent gains could reverse eased somewhat as members of the Organization of Petroleum Exporting Countries, as well as top non-OPEC producers like Russia, continued to comply with their November production cut agreement , and as outlooks improved for global crude demand .

"We expect oil prices to move up into the $60 (per barrel) level as we get into 2018" after averaging in the $50s this year, said Kurt Hallead, co-head of global energy research at RBC Capital.

As $40-per-barrel prices recede in the rearview, oil producers are increasing their capital spending commitments and U.S. rig counts are creeping higher. That is helping general investment funds and individual investors who fled the sector two years ago grow comfortable enough to take another look, not just at the U.S. explorers and producers, but at oilfield services and equipment-provider segments.

IBD'S TAKE:Oil drillers ranked a strong No. 19, Oilfield Services ranked No. 29 and Machinery/Equipment providers ranked No. 37 on Thursday among the 197 industry groups tracked by IBD .

Investing in the oilfield service segment is like a race and momentum investors are just now getting back into the game, according to Hallead.

"I think about it like a 4x100 relay race. Throughout 2016, the first leg of the race was won by value buyers, long-standing energy investors comfortable investing into the mist of the downturn. In Q4 after the OPEC meeting, the baton was passed to stock chart momentum players. Those players will hand off the baton to earnings momentum players sometime midyear and those players will have the baton until the end of the year at least."

Among the larger oilfield service providers, Hallead has Schlumberger rated outperform and on his "Best Ideas List" over Halliburton ( HAL ).

"If you look at its track record since 2010 vs. Halliburton on operating margins, return on capital, and free-capital generation, Schlumberger is best in class."

Both companies are projected to log significant earnings recoveries this year and next, after two-years of declines.

A Bigger Sandbox

Another company expected to rebound is equipment and services provider Baker Hughes. Hughes received a boost in October when General Electric (GE) announced it would fold its oilfield services operations into Baker Hughes, and come away owning 63% of the combined company.

The deal, set to close late this year, offers GE a constructive exit to the entity built up through more than $10 billion in acquisitions in recent years. It builds Baker Hughes into a powerhouse expected to generate $34 billion in revenue, able to "utilize GE's balance sheet to potentially get into integrated projects like some national oil companies, similar to the way Schlumberger participates in projects," said Hallead, who has an outperform rating on the stock.

Oil companies claim that, during the downturn, they lowered their breakeven costs by finding new ways to drill and finish wells faster, cheaper and more efficiently. One method involves using more fracking sand. Barclays analyst Dave Anderson said firms were using an average of 4,600 tons per well last year, up from 2,600 tons in 2014.

With demand for sand booming, sand providers and chemical companies are ahead of other oilfield service providers in seeing their prices recover, he said.

Frac sand and chemicals provider Fairmount Santrol is another stock set to outperform on Hallead's "Best Ideas List." Halliburton and FTS International are Fairmont's two largest customers. FTS has filled for a $100 million initial offering.

Opportunities Revolve Around Permian Basin

Jason Wangler, a managing director Wunderlich, has buy ratings on pressure-pumping firm Mammoth Energy Services (TUSK) and sand provider Emerge Energy Services (EMES).

Mammoth is a thinly traded stock that went public in October. Emerge is a former highflier expected to continue to post losses, at least through the end of this year.

"Everyone is buying, everyone is looking hard. Anyone with the idea of investing in energy are looking harder than they have at the service names in the last two to three years," Wangler said.

Land-driller Nabors Industries rounds out Hallead's "Best Ideas List," but some exploration and production companies also make attractive investments.

"Over the last three to six months we've seen more of the vanilla shops returning to the space," said Jeff Grampp, a senior research analyst at Northland Capital Markets. "Guys who haven't owned an oil or gas stock for two-plus-years are dusting off the playbooks and coming back into the space."

But the space so far seems to be limited to the Permian Basin.

The basin, which sprawls from West Texas into New Mexico, has seen a 60% jump in rig counts since hitting a low last May. Grampp doesn't expect a "widespread ramp-up of drilling rigs outside the Permian" this year. The Permian is an especially attractive play due to geology defined by multiple layers of resources. This allows producers to drill down once from a single production pad, then out horizontally into deposits in each subsequent layer.

While it might be too late for oil companies to buy prime acreage in the play at rock-bottom prices, it's not too late for investors to tap into the Permian.

"We still think there are some opportunities in the Permian to make good returns," Grampp said.

Chevron, Hess And More Nimble Names

Grampp has outperform ratings on Resolute Energy (REN) and the thinly traded Earthstone Energy (ESTE).

Resolute nearly went belly up in 2015, Grampp said, but managed to turn around its operations as oil prices rose.

Earthstone is a newer player in the basin. But its management team, led by CEO Frank Lodzinski, has a long history of operating public E&P companies, Grampp said. Earthstone has been scooping up privately held companies in the area and is focused in what Grampp called the "underappreciated" southern side of the Midland Basin.

Dave Meats, a senior analyst at Morningstar, likes RSP Permian (RSPP) for its nearly 50,000 "low cost, high quality" net acres in the Permian.

"We tend to favor smaller companies because they have asset portfolios that are less diverse than some of the bigger companies and have assets in the most profitable part of the shale basins in North America."

Also, Meats says, smaller companies are more nimble and can respond to price changes faster and accelerate drilling activity quicker than larger firms.

While oil major Chevron (CVX) is expanding its U.S. shale holdings, smaller firms entered plays first and scooped up the most profitable areas at the lowest prices.

Still, industry funds are "more geared towards bigger companies in the sector" like Hess (HES) and ConocoPhillips (COP), Meats said. He argues that this leaves smaller firms and individual investors access to smaller energy players.

Wangler has a buy rating on Pioneer Natural Resources (PXD), one of the upscale producers with 785,000 acres in the Spraberry section of the Permian. The analyst says it's trading at a discount relative to its peers.

The Goldilocks Price

Outside the prolific Permian, investing options in E&P companies are more limited.

Grampp likes Sanchez Energy (SN), which bought over 300,000 acres in the nearby Eagle Ford play for $2.3 billion from Anadarko Petroleum (APC) last month.

"They are in the good part of the Eagle Ford and with this acquisition they have done, and their cost structure, it makes them an advantageous Eagle Ford player," he said.

The one oil sector unlikely to see investors flooding back in anytime soon?

"Offshore drilling remains fundamentally challenged and will remain fundamentally challenged throughout 2017," Hallead said. "There are too many rigs chasing too little work."

He sees the counts of offshore rigs falling by 5% during the year.

Risks still remain with even the best stocks in the energy sector. While the OPEC deal seems to be holding, compliance could drop, weighing on oil prices. On the other hand, if oil prices jump suddenly, E&P companies could ramp up production too quickly, flooding the market with oil and sending crude tumbling again.

Meats said a $55 level for West Texas Intermediate crude is the "Goldilocks" level that "enables the industry to grow but doesn't let it overheat."


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

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

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