Best-Of-Breed Status Keeping Helmerich & Payne Near Fair Value

By Stephen D. Simpson, CFA | July 10, 2013 AAA

The past two- and five-year periods haven't been kind to the land drilling industry, but Helmerich & Payne (NYSE:HP) has fared quite a bit better than most. While rivals like Nabors (NYSE:NBR), Patterson-UTI (Nasdaq:PTEN), Precision Drilling (NYSE:PDS), and Pioneer Energy (NYSE:PES) have seen their shares decline from between 30% and 70% over the last two to five years, Helmerich & Payne is close to breakeven.

HP owes its success to a program of focused differentiation – namely, building high-spec rigs that not enable operators to drill the horizontal wells that are increasingly necessary to exploit oil and gas reservoirs, but to do so faster and with fewer drilling days. A significant recent increase in the dividend has demonstrated management's willingness to share success with shareholders, but the quality of this company is never far from the minds of Wall Street. Consequently, the shares don't look like a tremendous bargain today.

Becoming A Leader By Leading
Although HP has been in operation for quite a while, it has only been relatively recently that the company has started reshaping the land drilling industry. Years ago the company began an aggressive program of building its proprietary FlexRigs, and through subsequent generations HP has established itself with the most advanced fleet of drilling rigs, including over 250 with AC-powered top drive motors.

Interestingly, HP hasn't necessarily gotten to where it's at through innovation. HP didn't invent the top drive concept, nor were they the first to use AC-powered motors (that would be Pioneer). What HP has done, though, is come up with very solid rig designs and demonstrate a willingness to build out fleets before it became obvious to everybody else that such rigs would be needed.

SEE: Oil And Gas Industry Primer

As a result, HP now more or less shares the top spot in U.S. land drilling with Nabors and Patterson-UTI at around 12% share. Just as important, HP has consistently enjoyed better utilization rates and higher day rates than its peers – HP has recently been charging around $25,000 a day, while rivals are in the $20,000 to $21,000 range.

Can HP Maintain Its Leadership?
I don't mean to suggest that there aren't proprietary or patented aspects to HP's FlexRig designs. But the reality is that even companies with strong R&D legacies like Schlumberger (NYSE:SLB) and National Oilwell Varco (NYSE:NOV) can't rely just on IP to stay competitive – sooner or later, somebody else will figure out how to come up with their own version of your mouse trap.

To that end, Nabors has its PACE-X rig and Patterson-UTI has its Apex line of high-spec rigs, and both companies would no doubt like to carve into HP's 40% share of the high-spec rig market. While HP does have good relationships with large E&Ps like Exxon Mobil (NYSE:XOM) and Devon (NYSE:DVN) and benefits from operating almost solely on a contract basis, the reality is that the company will need to continue thinking and planning ahead to keep its edge in the field.

Tough Times Won't Last
Certainly there has been no shortage of press about the tough state of the U.S. land market right now. With natural gas prices at unappealing levels, most gas-focused E&Ps have significantly curtailed their exploration and drilling activities and even oil-focused producers have had to turn to procedures like pad drilling to improve well economics.

SEE: Hess To Become A Pure E&P Firm

Yet, even here there is some good news from HP. Recent utilization rates in the low 80%'s are substantially better than the 50% or so utilization rate seen four years ago, and the general consensus seems to be that U.S. land activity is bottoming out. Couple that with the company's recent determination that it could significantly increase its dividend (from $0.60 a year to $2.00) and maintain it to through a variety of stress-tested scenarios, and it's not too hard to feel some comfort about the company's long-time position.

The Bottom Line
The unfortunate bit for readers who don't already own HP is that the Street is also pretty comfortable with these shares and they don't look like a tremendous bargain. I prefer to use a 5x multiple to the next twelve months' estimated EBITDA (a slight discount to the historical average), and that generates a target price of about $69.50 – above today's price, but not by much. If you bump the multiple to historical average of 5.5x, the target moves to about $76 – which is better, but still not a compelling valuation to me.

Were something to spook the market and send these shares into the low $60s or high $50s, I'd certain reevaluate the situation. Like it or not, approaches like horizontal drilling and fracking are here to stay, and I believe HP's focus on high-spec rigs will serve it well as E&P companies continue to exploit unconventional resource plays.

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