Why You Should Buy these Top Oil & Gas Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Oil well service providers have seen nice returns of late. Over the last month, Halliburton (NYSE: HAL) has gone up 22.6%, and Baker Hughes (NYSE: BHI) is up 21.2%. While much of the appreciation has to do with investors looking beyond the overblown Macondo oil spill, it also has to do with strong evidence that shows that these firms actually have good fundamentals. Halliburton and National-Oilwell Varco (NYSE: NOV) are two top players in the industry with sustainable economic moats. They trade at unreasonably low multiples and are well positioned to create value as demand for increasingly scarce resources grows.
At a respective 10.3x and 9.8x past and forward earnings, Halliburton is rightfully rated a "buy" on the Street. Most importantly, it has a PEG ratio of 0.57, which indicates that future growth has not been factored into the stock price. In fact, assuming that the company meets EPS consensus growth figures, 2016 EPS will come out to $82.52 at a 14x multiple. Discounting backwards by 10% yields a present value north of $50. Put differently, the stock has around a 50% margin of safety that it would more than double.
What exactly will be driving Halliburton's growth? Despite the high capital costs common in the oil & gas sector, Halliburton is not only free cash flow positive but has also meaningfully expanded generation. During the second quarter, the company yet again posted better-than-anticipated results with EPS of $0.80 versus the $0.75 consensus. Perhaps most attractively, the company was able to weather a tough international market and grew international rig count by 3% sequentially.
Going forward, economic woes in China may reverse the trend in oil prices and encourage more drilling. By maintaining a leading role in unconventional plays, impacting the decline curve in mature fields, and participating in the deepwater expansion, Halliburton is well positioned to exploit positive secular trends.
National Oilwell Varco (NOV)
NOV is also an attractive pick at a respective 14.1x and 11.3x past and forward earnings. According to data from FINVIZ.com, it is rated a 1.8 out of 5 where 1 is a "buy." EPS is expected to grow 13.2% annually over the next 5 years. Assuming this is met, 2016 EPS will come out to around $9.81. At 14x earnings, the future value of the stock would be $137.38, or $85.30 in present terms at a 10% discount rate. Based on these numbers, reward meaningfully outweighs risk.
On the negative side, the stock trades at a higher multiple than the 13.5x 5-year average and free cash flow generation has been less than stable. FCF generation for the TTM ending 1Q12 was $1.6 billion compared to $1.1 billion in 1Q11, $1.2 billion in 1Q10, and $2.1 billion in 1Q09. By contest, Baker Hughes has done a stellar job in this respect. Free cash flow over the TTM ending June 30 went from $9.5 billion in 2Q08 to $19.4 billion in 2Q12. EPS for NOV over the TTM has been good - growing from $3.40 in 1Q10 to $5.16 in 1Q12 - but Baker Hughes has seen more of a turnaround, as it has grown EPS over the TTM from a low of $1.09 in 2Q10 to $3.96 in 1Q12.
Since past performance is no indicator of future performance, it is plausible that NOV can actually outperform peers in the years ahead. The firm recently agreed to acquire Robbins & Myers (NYSE: RBN) at $60 per share, which sent shares of the target 27.4% higher for the end of the day following the announcement. I believe that the integration will unlock significant revenue synergies, since Robbins & Myers has complementary products that could further assist clients. The addition of downhole tools, pumps, and valves would greatly help more aggressive drilling. With $11.3 billion in backlog orders for rig technology, NOV already has strong enough momentum to shift acquired lines onto existing customers while gaining new ones. I recommend buying shares to diversify across the undervalued industry and to capitalize on management's focus on accretive takeovers.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Halliburton Company and National Oilwell Varco. Motley Fool newsletter services recommend Halliburton Company and 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.