Filed Under:
Tickers in this Article: BJS, BAS, SWSI, RIG, NE, NOV, MDR, BHI
For the bulk of my youth, I worked in the oilfield service industry. My first job was working in my father's shop washing heavy equipment. It wasn't cleanest job, but I was making more money than the majority of my peers.

Over the years, I accumulated a working knowledge of oil industry while working for companies similar to BJ Well Services (NYSE: BJS), Superior Well Services (Nasdaq: SWSI), and Basic Energy Services (NYSE: BAS). I could recognize trends in the industry simply by paying attention to what kinds of services we were doing and where we were doing them.

Has Drilling Exploration Peaked?
In today's petroleum industry, there is a lot of talk about peak oil and global warming. That aside, here is the simple truth: society as we know it needs petroleum - if not directly into our gas tank, then for the petroleum-based products and plastic we use every day.

What do you think your mouse and keyboard are made of?

According to Baker Hughes International (NYSE: BHI), May of 1982 saw the highest level of drilling activity (1497 drilling rigs worldwide). In June of this year, the world rig count was only 67% of the 1982 level. Although current drilling activity is nowhere near the level it was back in the early 80s, it has been on the rebound. This rebound is likely to continue as more and more exploration and production companies (E&Ps) look for new reserves in order to quench the world's increasing demand for petroleum.

If we look at the financial data from some of the offshore drilling contractors (who will be drilling new wells for the E&Ps) and the companies that manufacture offshore equipment, you will find dramatic increases in both the top and bottom lines.

Drilling For Profits
One of the major offshore drilling contractors, Transocean Inc (NYSE: RIG), has seen an increase in revenue of over 34% during 2006. Compare that increase from the increase in revenue of about 10% during 2005, and 7% in during 2004. On a quarterly basis, Transocean has watched its revenue growth every quarter since the first quarter in 2005, and its EPS growth is nearly as impressive. It seems like business is picking up for Transocean.

Another offshore drilling contractor, Noble Corp. (NYSE: NE), has also been on a tear recently. During 2006, the company was able to grow on the top side by over 15%. Net income and EPS increased by over 25% during the same period. This is decent bottom-end growth for a company with a market cap of over $13 billion.

Although these drilling contractors are growing at a fast pace, eventually they are going to need more offshore rigs to either boost revenues, or to replace the ones that are wearing out. These rigs don't not come cheap!

When the time comes for more equipment, Transocean and Noble Corp. are going to have to turn to heavy equipment manufacturers such as McDermott International and National-Oilwell Varco (both discussed next) to increase their fleet of offshore rigs, and ensure continued growth.

Not Quite There
From a financial standpoint, McDermott International (NYSE: MDR) is in good standing. With annual revenue above $4.1 billion, ROA at a healthy 12%, and the return on average equity of over 130% over the last twelve months, MDR has been a winner during 2006. Is it a good time to buy?

Over the next five years, the Street expects McDermott to grow its bottom line by a mere 16%, ahead of the industry's average pace by 4%. If the expectations pan out, then MDR is currently trading at a somewhat rich PEG ratio of about 1.38-times. Further, EPS estimates for this stock are pegged at $4.32 per share for 2007, which means MDR is trading at about 20-times forward earnings.

It appears the market has already priced in this future growth, so it might be a good idea to sit back for a bit and pick it up on a pullback.

Top Notch
Since the end of 2003, National-Oilwell Varco (NYSE: NOV), has increased its revenue by more than 150%. During 2006, this increase was more than 51%. Increases in net income and EPS came in at the tune of 138% and 113% respectively during 2006. Further, the company's order backlog has increased to about $6 billion as of the end of fiscal 2006, which will provide revenue into 2008.

About 50% of National Oilwell's revenue is derived from rig manufacturing. A hiccup in offshore drilling demand, could hurt revenue, as drilling contractors cancel orders and park some of their equipment until demand picks up again. This makes NOV a risky play in my mind.

That said, I wouldn't be too afraid. Currently, this stock is trading at about 23-times current earnings, about 17-times forward earnings and has a PEG ratio of about 0.82. With this margin of safety, and high growth potential, investors who get in now should be somewhat protected from any downside volatility.

For more on this sometimes risky industry, see our Oil And Gas Industry Primer.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

comments powered by Disqus

Trading Center