Why I Still Believe Oilfield Service Stocks Will Outperform

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Despite improving natural gas prices, oil & gas suppliers have fallen considerably during the past 3 months. They trade not only below historical levels, but also have excellent growth curves ahead. I encourage aggressively buying shares in the market, but the question is "which stock will outperform in the market"? The analysts clearly have their favorite pick. Here's my take on 3 major producers in the field.

Halliburton (NYSE: HAL) Provides Excellent Value

At 9.7x past earnings and a PEG ratio of just 0.5x, Halliburton is selling at a steep value discount. The consensus price target is $42.16, and Dahlman Rose just last month issued a "buy" report with a $47 price target. After falling 23.8% from the 52-week high, the stock currently trades at only $30.46, so the potential reward is excellent.

There are several reasons why I am bullish on the stock. First, natural gas trends are starting to improve and will be driven even more by large secular transition in America's energy resources. Excellent momentum in Brazil and Mexico has also promised strong international returns. A first-mover advantage in Iraq will also help drive strong returns. An aggressive growth strategy--demonstrated by the takeover of Petris Technology--has positioned the company to be more of a vertically-integrated player. Petris provides data integration solutions that will assist Halliburton's customers accessing reservoirs. The launch of "KnoesisSM" will further help drillers better understand their reservoirs.

For six straight quarters in a row, management has met or beat expectations. Despite this, it is valued at well under its historical 13.3x average PE multiple. Operating cash flow has meanwhile grown by more than 50% during the last 3 years. ROE has further gone up from the 21.6% trough in March 2010. Going forward, investors should closely follow international performance. Results have strengthened in key geographies, and investments in EMEA and Latin America are clearly paying dividends. During a time when oil & gas producers were downsizing operations, Halliburton was there to supply the market, and this loyal support will pay off big with renewed activity in a full recovery.

Why Analysts Love Schlumberger (NYSE: SLB) Over Baker Hughes (NYSE: BHI)

Like Halliburton, Baker Hughes and Schlumberger are unreasonably cheap. Baker Hughes trades at just 12.5x past earnings versus a historical 5-year average PE Multiple of 18.5x. Schlumberger trades at 16.5x versus a historical 19.5x level. During the past 5 quarters, Schlumberger was ahead of consensus 4 of the times (average beat: 2.4%), and Baker Hughes was ahead of consensus just 2 of the times (average beat: 15.9%). Analysts currently rate Baker Hughes a "hold" despite the PEG ratio of 0.94x vs. a "buy" for Schlumberger. 

The latter is expected to grow annual EPS by 16.1%--nearly 250 bps greater than the competition. The Street's bullishness was perhaps best showcased when, last month, Howard Weil upgraded the stock from "market outperform" to a "focus stock"--those rare picks analysts say will generate explosive returns for readers. A days before that report came out, FBR was calling SLB a "$92 stock". It currently trades at $68.22. So while the firm is forecasted for stronger EPS growth and trades under its historical multiple, the question naturally follows whether this is worth the large premium to Baker Hughes and Halliburton.

In my view, Schlumberger is an attractive investment, but it is any more so than Halliburton or Baker Hughes for that matter. Last week, Baker Hughes noted that its international rig count was up 62 y-o-y and totaled 1259. Even still, market conditions have been challenged on both the domestic and international fronts. Pressure pumping business has been unbalanced from over capacity, and customers are postponing activity. The postponement has stemmed from debt-ridden balance sheets and sovereign debt worries. So, in this environment, the biggest player (Schlumberger) may very well be best prepared to deal with the headwinds. But I wouldn't put all of your eggs in one basket--oilfield services is not a "winner takes all" market.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Halliburton Company. Motley Fool newsletter services recommend Halliburton Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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