Play The Oil Market Slump With This Key Stock

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The price of a barrel of oil fell below $85 this month. Production hit a 15 year high this week, despite lower demand. All of this economic pressure is pushing stock prices down for major oil companies. I believe this presents a good buying opportunity for those looking to enter the oil and gas market.

The demand for oil is diminishing in the United States. But population growth and increased demand in emerging markets abroad means big oil will be in business for the foreseeable future.

So, which oil company should a prospective investor buy? Instead of buying the explorers and drillers, I recommend you buy the company that supplies all of them with rig building equipment.

The biggest supplier of parts to oil companies is National Oilwell Varco (NYSE: NOV). The company estimates that 90% of the mobile offshore rig fleet and the majority of the world’s larger land rigs use its parts. The company is a market leader and innovator, as well as a service provider to some of the biggest companies in the world.

Earlier this month, Exxon Mobil (NYSE: XOM) announced plans to acquire Canadian oil and gas company Celtic Exploration (CLT.TO). The move telegraphs Exxon’s intent to explore the shale in Alberta to which Celtic owned the rights. The project will require massive rig development, and National Oilwell Varco is standing ready to supply.

Bigger oil companies, such as Exxon and BP (NYSE: BP), are currently looking to buy out smaller exploratory companies that own land in the North Dakota and Alberta region. BP has bought out five companies this year alone. Buying up small companies with big land holdings is a conservative way for bigger companies to grow.

Once the big company comes in, it is mainly looking to purchase the land the smaller companies own. It can then start developing quickly because it knows the land is rich in oil. National Oilwell Varco stands to benefit from the recent surge in acquisitions.

The government is also focused on developing more oil and gas rigs and refineries in the United States. Regardless of who wins the election next week, both nominees promised the American people to reduce our dependence on foreign oil. This means opening government land to new development. National Oilwell Varco could see a huge boost in revenues from the government promoting drilling on oil rich government owned land.

Many oil companies’ earnings reports came in below expectations this quarter. National Oilwell Varco reported its third quarter earnings last Thursday. The company met analysts’ expectations on earnings and revenue. However, profit margins fell from the previous year’s marks. Overall, the report compared favorably to others in the oil sector.

Earnings came in at $1.43 per share representing a 14% increase from the third quarter last year. Sales went up significantly with $5.32 billion in revenues. That figure represents a 42% increase over the same period a year ago. In addition, the company announced its backlog of orders is now up to $11.66 billion.

Last week, National Oilwell Varco’s stock fell 7.5%. It currently trades at a forward P/E of just 11.4 and a PEG of 0.8. Comparatively, the industry trades at a forward P/E three times greater at 34.2 and a PEG of 1.6. Its largest competitor, Cameron International (NYSE: CAM), is slightly more expensive with a forward P/E of 12.9 and a PEG of 1.2.

Analysts expect the company to grow profits at a 17.9% rate over the next five years. This is only slightly faster than Cameron’s expected growth at 17.2%. If National Oilwell Varco can improve its backlog production that number could dramatically outpace Cameron.

Cash flow has declined this year for National Oilwell Varco. The main cause is from the numerous acquisitions the company made. Most notably, the company acquired the Wilson piping and fitting unit from Schlumberger (SLB). It is also reported that the company will acquire Robbins & Myers (RBN) for $2.5 billion.

The acquisition of smaller companies and divisions is one of the main ways National Oilwell Varco grows its business. In fact, revenues from this past quarter in the company’s distribution and transmission segment rose 173%, driven mostly by acquisitions.

Instead of dolling out a dividend, the company reinvests the money and grows the company through value-adding acquisitions. It has successfully done so for years, and I expect its newest acquisitions to add future revenue as development expands.

With so many oil companies hurting these days, it seems counter intuitive to buy into the industry. Yet, that is how some of the best investors make their money. In fact, Warren Buffet is a fan of National Oilwell Varco, and his Berkshire Hathaway (BRK-A) company bought 2.84 million shares of the company earlier this year.

The demand for oil will continue rising despite the move toward renewable energy. Oil companies are looking to drill more, and the government is planning to promote those companies actions, especially in the United States. National Oilwell Varco is positioned well to take advantage of upcoming oil rig developments. After slipping in price last week, despite meeting analysts’ earnings expectations, I see its current price at under $75 per share as a good buying opportunity.

StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of National Oilwell Varco and ExxonMobil. Motley Fool newsletter services recommend National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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