Time to Pull the Trigger on Four Oil Service Stocks

by: Larry Bellehumeur August 17, 2008 | about stocks: BHI / RIG / SLB / WFT    

Larry Bellehumeur

About this author:
Become a Contributor Submit an Article
  • Font Size:
  • Print

As a Value Investor, I routinely find myself stepping in front of "Moving Trains" to buy beaten up stocks. Sometimes when you do this, you get run over and end up catching a "Falling Knife". Other times, you find yourself at the beginning of a "Hockey Stick curve climb" (sorry, Canadians have to refer to Hockey once in a while!).

With the incredible fall of the price of oil recently, many oil services stocks have been dragged down considerably. Some of the observed drop in these stocks might not be fully warranted, though. Although their clients (namely the Large Oil Companies and Nationalized Oil Programs) may receive less money for their barrel of oil today than earlier in 2008, the fact that oil prices are still over $100/barrel means that there shouldn't be any significant impact on the search for new oil production. As well, many of the oil services companies have signed long-term contracts for set rates, so earnings are unlikely to be affected significantly by Day-to-Day Commodity price swings. In my opinion, oil would have to fall below the $60 mark for there to be a significant downturn in the work for these companies.

Here are 4 companies that I like for the long-term investor:

1) Schlumberger (SLB)

If you are going to only own one oil services company in your portfolio, you could do a lot worse than owning the largest of them all. With its incredible array of services, Schlumberger has its "tentacles" in all aspects, from the early stages of E&P (Seismic testing) to Drilling (huge array of Well Services) to Project Management and IT Services. As well, its incredible geographical spread means that the company doesn't receive more than 30% of its income from any one particular region, providing some protection in the event of political instability or an economic downturn.

Of course, this great company doesn't come cheap... the great ones never do. Schlumberger almost always trades at a significant premium to the S&P, but has consistently shown its ability to increase its earnings and cash flow at an excellent rate, justifying the premium.

With an estimated 2009 earnings of about $6.00, and an anticipated current year P/E of 20x, I suspect that Schlumberger will make its way (sometime in 2009) to new highs, touching the $120 level. This would be a 30% climb, which is a great return in this current market.

Again, not a cheap stock at this price, but one that has great long-term value.

2) Weatherford (WFT)

Like Schlumberger, Weatherford also offers an incredible array of oil services to its valued customers. It also has some long-term contracts that help to stabilize its earnings, at least somewhat.

One way that Weatherford does differentiate itself a little bit from SLB is that fact that it gets a higher percentage of its revenue (about 50%) from North America. While this has been improving slightly in the past few years, it does leave the company a little more exposed to a potential downturn in the North American natural gas market than SLB. This extra leverage may not be a bad thing, however, as many analysts are predicting an upturn in natural gas drilling over the next few years in North America.

Also, unlike SLB, Weatherford does not pay a dividend, as they are still strongly looking for key acquisitions in this market. Weatherford does trade at about ½ of the price to book ratio of SLB, making it a better value, at least in my opinion.

With an estimated earnings just shy of $3 for 2009, and an estimated current year P/E of 18 (reflecting its lack of geographical diversity), Weatherford should see the mid-$50 range sometime in 2009. This would make it about a 50% upside from its close on Friday.

3) Baker Hughes (BHI)

Most high-school boys have (or had) a gal that always breaks your heart. This is kind of how I feel about Baker Hughes. Sure, it has been a good performer for me (a little over a double, in four years), but it always seems to find a way to disappoint here and there on the earnings front.

Despite that, I am still recommending BHI for the long-term investor. While its diversity and scope of services may not be as strong as SLB, Baker Hughes does have good exposure to all areas of the world (with only a 30% exposure to the US) and a good balance to its offerings to its customers.

It does appear to have a strong tie to the Western Canadian Sedimentary Basin, as evidenced by its miss in earnings last year during the temporary downturn in activity in the region. Nevertheless, BHI trades at a discount to SLB and WFT that (I believe) more than takes all of these factors into account.

With an estimated earnings of around $6.50 for 2009, and a P/E of 16 (which reflects the expected growth rate, according to analysts), Baker Hughes should pass its previous high and break into the $105 range sometime in 2009.

4) Transocean (RIG)

I'll leave the stock that is the most undervalued for last! Critics will point out its greater vulnerability to the actual price of the commodities than other Oil Services companies (since it costs a staggering amount more to drill off-shore, these projects may be cut first in the event of a quick downturn in the price of oil). As well, I have observed on Bloomberg how a few analysts were concerned about both competition coming online in 2-3 years (pressuring their day rates) and how they are more exposed to natural disasters, such as hurricanes and tsunamis.

Having said all that…..this stock is dirt cheap. Few stocks could have had the meteoric rise that RIG did, and still be considered cheap (I have owned this stock since I bought it in the $40 range, sometime in early 2005). RIG's earnings growth rate has also been equally as spectacular.

Many of RIG's customers have committed to long-term rates, providing a modest amount of stability. Most rigs are booked up for the next several years, with PetroBras having locked up many of them for their recent off-shore discoveries. As well, day rates for their products have sky-rocketed (averaging almost $240K in Q2, 2008), with some rigs fetching much more than that.

Finally, I would have thought that this stock would have had more of a pop with one of the key election topics being how the US should focus more on off-shore drilling. As the largest Oof-shore driller in the world, this would likely be a boom for RIG. Barring an absolute collapse in the price of oil (perhaps back down to the $50 level?), RIG's services will be in huge demand for years…..

Based on a 2009 earnings estimate of $16.00 (I've lowered it a bit from consensus earnings, to be conservative), and a current year P/E ratio of 12, this stock might come close to hitting $200 some time in 2009. I believe that eventually, when the market believes that $100 really is the floor for oil prices, and there is further talk of US off-shore drilling, this stock even has room for some multiple expansion, making my targets seem very conservative.

Disclosure: Long RIG, BHI, WFT. In addition, BHI and SLB are customers of my company.

Related Articles

This article has 24 comments:

  •  
    Aug 17 09:42 AM
    drill here drill now!
    Reply | Link to Comment
  •  
    Aug 17 10:28 AM
    You are speaking my mind.
    Reply | Link to Comment
  •  
    Aug 17 10:36 AM
    My only concern with RIG is its low income tax expense. With as much as 80% of revenues locked in through 2010-2, I feel that leaves limited room for profit growth when the tax expense jumps as much as 20% over that span. Any thoughts?
    Reply | Link to Comment
  •  
    Aug 17 11:54 AM
    On RIGs taxes:

    From RIG's 10Q filing ending June 20, 08 I understand

    1.) They are a Cayman Islands company. The earnings are not subject to income tax in the Cayman Islands because the country does not levy tax on corporate income.

    2.) They pay taxes all over the world through operation of various subsidiaries in a number of countries throughout the world. Income taxes have been provided based upon the tax laws and rates in the countries in which operations are conducted and income is earned. .

    3.) They pay taxes in the US only for key subsidiaries that reside in the US.

    4.) The estimated annual effective tax rate for the six months ended June 30, 2008 and June 30, 2007 was 12.5 percent and 14.9 percent, respectively based on estimated annual income before income taxes for each period after adjusting for certain items such as net gains on rig sales and various other discrete items.

    5.) The taxation rate is low and has dropped since last year. Due to the diversity of the places where taxes are paid, I would assume a certain stability of the tax rate. The big unknown is the liability for unrecognized tax benefits that increased to $482 million, including interest and penalties. This may or may not be due some time later. There are some disputes going on with the tax authorities in the US and Brazil.

    As a consolation in case of liquidation of the company the liability probably wont be paid off.
    Reply | Link to Comment
  •  
    Aug 17 12:33 PM
    Thanks. That was much more pleasant than sifting through their annual/quarterly reports
    Reply | Link to Comment
  •  
    Aug 17 01:01 PM
    Thanks, Freefall......I also visualized myself spending a lot of time answering that questions....

    Many thanks to everyone for reading. There is an interesting article (with a completely opposite view point) on the front page of SA. It talks about oil plummeting to $30 a barrel. I don't agree, but it is worth reading....

    Larry
    Reply | Link to Comment
  •  
    Aug 17 01:36 PM
    Like your stock picks, but time now to pull the trigger? Hmmm, maybe in coming weeks....
    I'm not sure I agree that oil will go to $30-$50 (as in said article above). But, I do respect Jim Kingsdale's opinion on energy/oil, he sees oil hitting $85 or lower, then settling ???. Thus, RIG has been in a downward trend inversely correlated with the price of oil since July 1. As oil descends to and past $100, RIGs price will also descend.
    Reply | Link to Comment
  •  
    Aug 17 02:10 PM
    Is the TAX rate low because they are booking future income today?

    Most companies that sign multi year contracts book all the profit at once,
    then they keep a separate set of books for the tax man.
    Reply | Link to Comment
  •  
    Aug 17 05:59 PM
    The technicals remain ugly, but the fundamental values are exceptional, the sector is very oversold, no other sector offers such high visibility of strong earnings growth at such low valuation multiples, and the political winds are becoming more favorable. Somehow, buying the sector here does not seem to qualify as "catching a falling knife." RIG is my largest holding in the sector, and I also love DRYS as an undervalued play on ultra-deep water drilling.
    Reply | Link to Comment
  •  
    Aug 17 06:14 PM
    There is no chance for oil to drop down to $30. That is a joke. These companies are all good long term buys.
    Reply | Link to Comment
  •  
    Aug 17 06:39 PM
    DaveW,
    I don't think there is anything in the article that suggests oil is dropping to $30-$50. Only that RIG's services will be in big demand unless the price falls to that level. I agree if oil drops below $100 then RIG stock is likely to be lower than it is today (that a direct correlation by the way, not inverse).

    jimmy46,
    RIG does not book revenues until they are collected.

    IMO, RIG is likely a very good long term hold - just don't expect the same appreciation it's had over the past 3 years. Oil won't triple in price again.
    Reply | Link to Comment
  •  
    Aug 17 08:31 PM
    244491 -- I always appreciate all comments, even ones such as yours. You might want to do some research first, however....Bellehumeur is a French-Canadian name. There are two things that you can be sure of with a French Canadian....they like to drink beer and are Catholic! =) I didn't miss the Oil boom, by the way...at one point, I had over 50% of my portfolio in Canadian Oil stocks, and they were a 4-bagger in about 3 years. I've since paired down to about 20% of my portfolio.

    Tyler / Camden -- I personally think there is more chance of oil hitting $200 than $30 anytime soon. I was referring to an article on Seeking Alpha's front page, suggesting such a demise in the price of oil. Thanks for your point on RIG's revenue collection, Camden.

    Having owned RIG for a long time, I did take some profit when it shot up to $175 earlier this year, but it remains a core holding of mine.
    Reply | Link to Comment
  •  
    Aug 17 08:52 PM
    Larry, your reply to 244491 was a class act. Personally, i wouldn't have dignified his drivel with a reply, but then again, I probably don't have your sense of humor.
    Reply | Link to Comment
  •  
    Aug 17 10:57 PM
    I really like SLB and RIG. As a value investor, they need to come down 10% from these levels to get in. Remember, value investors wait for a fat pitch. You don't have to swing at anything until it is as sure a hit. This market is so uncertain one needs a REALLY good price to pull the trigger.
    Reply | Link to Comment
  •  
    Aug 18 01:12 AM
    I'm still very skeptical about more U.S. drilling in this country. I believe we need to drill more and I can read and hear many seemingly change their rhetoric about drilling but I still feel it will only amount to election year rhetoric that will end after the first week of November. They could even vote to allow more drilling but then make it prohibitively expensive by adding ridiculous new standards before any new drilling can begin. I've also read that 80% of all available oil drilling operations have already been contracted out to Brazil. Anyone have any information on this?
    Reply | Link to Comment
  •  
    Aug 18 02:21 AM
    Dear user 24491, were you born a dumbass or did you have to work hard to become one? In the future please keep your pedantic comments to yourself.
    Reply | Link to Comment
  •  
    Aug 18 02:44 AM
    DUUDE, I believe the 80% you refer to is for deep well drilling only. I have heard this figure before as well. If I remember correctly there are only 30 or so deep water rigs in the world today and PBR does have many of them under contract. See the article in SA entitled "Petrobras is hoarding the world's deep sea drillers".
    Reply | Link to Comment
  •  
    Aug 18 09:19 AM
    As a final comment, everyone....

    Many thanks for reading....

    Oroloco -- Thanks for your kind words. Everyone is entitled to their opinion, no matter how it may differ from the rest of us, and even if it is written in bad taste.

    LarryH -- I do see your skepticism, and these stocks may very well have another 10-15% to fall before this correction is done. In fact, I still haven't pulled the trigger on SLB, hoping for just a bit lower of an entry price.

    Duude / Crackhead -- That is correct, Petrobras is drilling a massive discovery off-shore. What I was referring to is how this, combined with the potential for the US to increase their drilling, might cause a further hike in the Day rates for RIG. Further bullish sign to me....
    Reply | Link to Comment
  •  
    Aug 18 06:02 PM
    Camden, thanks for the correction, I indeed did mean to write 'directly correlated', sometimes my words are inversely correlated to my thoughts! I will, however, correct you: the author did refer to a recent SA article on oil going to $30-$50 range (see second to last P and author comment).
    Reply | Link to Comment
  •  
    Aug 19 07:00 AM
    Oil price direction is key. Jim Rogers spoke about oil in his most recent interview.

    Supply and demand = Price going up (in the long run)

    jimrogers-investments....
    Reply | Link to Comment
  •  
    Aug 19 08:10 AM
    Remember nasdaq 2000? When the market falls, no oil company will be spared.
    Reply | Link to Comment
  •  
    Aug 19 11:37 AM
    I too like the future prospects of Rig.. swimming in PBR right now and feel the need to hold back a little longer for either SLB or RIG to take a bit off... even though they are both creeping up. This market right now is very inconsistent. Tomorrow they both could be down. Not going to play day trader with my limited cash and commission fees.
    Reply | Link to Comment
  •  
    Aug 19 01:16 PM
    I'd like to mention HOS in this group. Like RIG, Hornbeck is another offshore E&P service provider that should benefit both from an increase in activity and a fall -- at least near-term -- in fuel prices. Long both SLB and HOS.

    ps. also another Canuck...
    Reply | Link to Comment
  •  
    Sep 10 10:28 PM
    so larry...what do you think about WFT now that it is trading under $30? why didn't it bounce today with the other big boys like SLB, HAL and BHI?
    Reply | Link to Comment
More Comments on SLB ยป
Top Rated Comment Streams:

Numbers are net rating-

See all Top 100 »
More by Larry Bellehumeur

Investment Resources
Money Management
Research
Seeking Alpha provides these ads as a service to its leading contributors
Articles on related themes
Long Ideas
Exploration & Production
Alternative Energy