3 Stocks to Buy for a Rig Revitalization

by Aaron Levitt | July 16, 2013 2:48 pm

Years of low natural gas prices haven’t exactly inspired E&P firms to keep up production. In response to sustained low prices, natural gas rigs in operation have been largely falling or flatlined since October 2011 — and that’s been poor news for firms that provide contract drilling services for the industry.

However, recent upticks in both natural gas and oil prices have moved the needle on the number of rigs operating across North America. That might signal a bottom for the contract drilling sector, and that in turn could point to a few opportunities.

Bouncing Off 18-Year Lows

For those companies that operate in the contract drilling sector, rising shale production has been both a blessing and a curse. Their fortunes rose heavily as the boom took place and every E&P plowed head first into regions like the Utica, Bakken and Marcellus.

However, that zeal came at a steep price. Prices for natural gas plunged as the storage depots became full. As such, rig counts tanked and profit margins and earnings at the major contract drilling firms began to free fall. Since peaking in October 2011 — at 936 — the number of rigs actively searching for natural gas has plunged about 62%.

Yet times might be a-changin’.

With the promise of new liquefied natural gas export facilities, warmer summer weather and the potential for rising manufacturing gains, nat-gas prices have steadily risen during the past year or so. That’s making drilling for the fuel much more appealing to variety of producers. At the same time, higher West Texas Intermediate crude oil prices is buoying production in places like Eagle Ford.

All in all, that’s a recipe for rising rig demand.

According to oil service firm Baker Hughes — which publishes stats on that demand — that trend seems to be holding true. The company reported for the week ending June 28 that rigs targeting natural gas increased to 353[1] — up from 349, or the lowest number since June 1995. More impressive, that was the first gas-directed rig count gain in more than six weeks. U.S. oil rigs also saw an improvement to 1,395.

At their core, rising rig counts signal that energy producers are feeling more confident about the current price environment for both crude and natural gas. In the end, that means they are more willing to put capital to work and produce energy. That could be a boon for those beaten contract drillers whose services will now be in greater need.

Here are three stocks that could be on the upswing if so.

Patterson-UTI Energy

With 330 rigs under its umbrella, Patterson-UTI Energy (PTEN[2]) is one of the largest dedicated onshore land drillers in North America. The company currently has 181 of those rigs in action across the various oil and natural gas hotspots — nearly three times the amount of rigs from its low of just 60 reached in May 2009.

Yet, there still could be more rig gains for PTEN.

Patterson-UTI has one of the most innovative rig designs in the sector. Its proprietary “walking” Apex rigs allow for multi-directional pad drilling capabilities, which reduces well construction time and overall drilling costs for customers. But these Apex rigs don’t come cheap, and provide plenty of extra rental fees for PTEN. As E&P firms look to add more rigs, they’ll actively seek out ways to cut costs, that’ll directly benefit Patterson.

PTEN shares currently trade at a fair 12 times earnings. It does offer a dividend, but at a 1% yield, it’s not much of a consideration.

Helmerich & Payne

Something can be said for buying the “best of breed.” In the contract drilling space, that’s Helmerich & Payne (HP[3]).

HP has managed to avoid much of the decline in drilling rigs over the last few years as it focuses on more high-end markets. Like PTEN, Helmerich & Payne’s rigs feature some of the most advanced drilling technologies — with the bulk being newer high-powered horizontal drilling setups. HP currently dominates the high-spec rig market with a 40% share.

That strong fleet of advanced FlexRigs have allowed HP to charge roughly rental fees of around $25,000 a day; sector rivals are typically only able to charge between $20,000 and $21,000. Yet even with this higher fee rate, analysts estimate that HP will see its active rig count jump to 286 in 2015 — up from 267 in previous estimates.

As with PTEN, that means plenty of cash flows and rising earnings for Helmerich & Payne shareholders. Analysts at Jefferies predict that HP will generate $2.40 in free cash flow after paying its juicy $2 dividend, yielding 3.1%. Helmerich & Payne shares are just a touch cheaper than PTEN shares at 11.4 times earnings.

Precision Drilling

Things haven’t been kind to Precision Drilling Corporation (PDS[4]) since the “October Massacre.” However, things might be turning around for the former Canadian royalty trust.

Like the previous two contract drillers on our list, Precision’s investment in 70 new advanced rigs during the past few years is finally beginning to bear fruit and help the firm beat analyst expectations and deliver profits. In its most recent earnings report, adjusted EPS of 33 cents and revenues of $596 million were both down year-over-year, but still beat analyst estimates. Rising rig activity across the U.S. and Canada should help strengthen the company’s bottom line.

More importantly, as with both PTEN and HP, Precision should be able to charge higher day rates for its more advanced rigs. That will help pad cash flows and the firm’s 2.2% dividend.

The one downside: Shares of PDS are the most expensive at 76 times earnings, which is frothy even against expected earnings growth of nearly 20% for the next fiscal year.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Endnotes:
  1. rigs targeting natural gas increased to 353: http://www.reuters.com/article/2013/06/28/energy-natgas-rigs-idUSL2N0F417B20130628
  2. PTEN: http://studio-5.financialcontent.com/investplace/quote?Symbol=PTEN
  3. HP: http://studio-5.financialcontent.com/investplace/quote?Symbol=HP
  4. PDS: http://studio-5.financialcontent.com/investplace/quote?Symbol=PDS

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