Oil Services Still The Best Way To Play Crude

By Todd Shriber | October 22, 2009 AAA

With crude oil finally pushing past $75 a barrel and coming to rest at a fresh 52-week high around $77 a barrel, hope will no doubt be renewed that black gold is poised to make another bullish run. While rising oil inventories and tepid demand make a climb back to the 2008 high of nearly $250 a barrel unlikely, clearing resistance at $75 could mean some higher prices are on the way.

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The previous bull market in crude may have alerted more than a handful investors as to what the best equity plays on rising crude prices are. And let's be honest: the best equity plays on rising oil prices are NOT traditional exploration companies like Chevron (NYSE: CVX) and ExxonMobil (NYSE: XOM).

While these are decent stocks with robust dividends, Chevron, ExxonMobil and other oil explorers tend to lag crude's price appreciation, which can be a frustrating scenario for investors.

So where is an investor to turn to profit from rising oil prices? Oil services are the answer. A quick look at the Oil Services HOLDRs ETF (NYSE: OIH) shows how tightly correlated these stocks are to the price of oil. That makes OIH's advancement to fresh 52-week highs no surprise as the underlying commodity accomplished the same feat. It might be time to take another look at some of the key players in the oil services sector.

All About The Outlook
Halliburton (NYSE: HAL) Forward P/E: 22 Free Cash (End of 2008): $1.03 billion
Halliburton is one of the largest suppliers of goods and services to the energy industry and as such is one of the bellwether stocks in oil services sector. The company is expected to report third-quarter earnings of 26 cents a share on sales of $3.41 billion and with the stock already hovering near its 52-week high, a positive report and some bullish guidance should send Halliburton's share above $31, a level not seen in more than a year.

The company has been trying to improve its international profile through contracts in Mexico and Brazil, but it is still more exposed to North America's natural gas market than its rivals. That's an issue to be wary of given the precipitous fall in natural gas prices over the past two years along the lines of 70%.

That said, Credit Suisse recently raised its price target on Halliburton to $34 a share from $26 and the company recently signed a contract with Talisman Energy of Canada to provide drilling fluids on the Norwegian Continental Shelf. Those catalysts combined with a solid earnings report could lift the stock into low to mid 30s.

A Cash Flow King
National Oilwell Varco (NYSE: NOV) Forward P/E: 16 Free Cash: $1.78 billion
If you spot an uptick in offshore drilling projects by the major oil explorers, National Oilwell Varco is sure to benefit. NOV makes many of the parts and components used in oil and gas drilling operations, so if you're bullish on NOV, your mantra should be "drill, drill, drill."

NOV enjoys a unique competitive advantage in that it sells most of the parts that a rig needs to run, trains the workers on how to operate the rig and services the parts that it supplies. That makes it hard for a company that has bought NOV's products to move to an NOV competitor for servicing needs.

While NOV doesn't pay a dividend, it's free cash flow outpaces its long-term debt obligations and the company has shown a knack for using its war chest to make prescient acquisitions. The stock is hovering right near its 52-week high, but it has a long way to go to touch its 2008 peak of $92.70. While it may take a while to see that price again, if oil moves to $90 a barrel, NOV should rise to the high 50s.

Winning With Weatherford
Weatherford International (NYSE: WFT) Forward P/E: 18 Free Cash: -$1.4 billion
Weatherford International, like Halliburton, has been dinged by its exposure to natural gas. That glum news aside, some analysts believe that natural gas prices should find a bottom sometime this year and that thesis has led to some decent institutional buying of Weatherford's shares. And like Halliburton, Credit Suisse is bullish on Weatherford as well, saying the company has the fastest top line growth prospects in the sector.

Weatherford recently completed a $490 million acquisition of BP's (NYSE: BP) Russian oilfield venture to bolster its international profile and with only 30% of its revenue coming from North America, Weatherford's international exposure could be a positive catalyst going forward.

While the company was cash flow negative at the end of last year, that was attributable to spending to gain market share abroad and the expectation is that Weatherford will be cash flow positive in 2009 and 2010.

The Bottom Line: Oil Services Rock When Oil Rises
If we continue to see bullish moves in crude oil prices, the stocks mentioned here are poised to benefit. Halliburton's earnings reports holds the keys to its near-term fortunes and Weatherford's international exposure is a source of allure, but we'd like to see natural gas prices firm a bit before getting heavy in those stocks. If rig counts continue to expand and new drilling projects are initiated, NOV stands as the best of breed. (To learn more, see The Industry Handbook: The Oil Services Industry.)

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