The Case for Buying Stock in Oilfield Services
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you are bullish on natural gas, it makes sense to buy the industry suppliers… especially at today's multiples. Oilfield service companies are trading at a historical low for such promising growth ahead. While the US pressure pumping business is, fittingly, under pressure and margins are narrow from excess capacity in oil basins, this headwind has been overblown. Below, I review three stocks and my outlook on their futures.
Why You Should Buy National-Oilwell Varco
The oilfield service provider trades quite attractively at a respective 12.2x and 10.4x past and forward earnings. Moreover, future growth is not being fully factored into the stock, as evidenced by the 0.84x PEG ratio. 25 of 26 analysts rate the stock a "buy" or better--11 of which say "strong buy" (the other has a "hold"). And, overall, the consensus price target is $94.20--a premium of 35% to the prevailing price. With a return on invested capital of 11.6% (130 bps better than the industry average), management is also creating growth.
There are several reasons why you should be optimistic about National Oilwell Varco (NYSE: NOV). At 1.5x book value, the company is comparatively cheap against the 2.1x industry average--unreasonably so in light of being the #1 leader in drilling equipment. Recent strength, particularly in deepwater equipment, was seen in better-than-expected third quarter results. Warren Buffett has added NOV to his portfolio--the only oil & gas buy recently disclosed. Billionaire oil baron T. Boone Pickens has also forecasted for natural gas to hit upwards of $5 as early as next year and that NOV will be a prime beneficiary by virtue of its opportunity in shale. Half the revenues have come domestically, but the big opportunities lie abroad. Shares have been hit from weak US land drilling, so the growth seen from international markets is a result of not only naturally higher volumes, but a clear management shift in strategy.
It should be of no surprise then that Barron's has argued NOV will grow substantially over the next few years. Much of this growth will be driven by an improving rig newbuild cycle organically and buying out undervalued businesses inorganically. Equipped with industry-leading integration, I have little doubt that NOV will realize substantial revenue and cost synergies through the latter.
Small Cap Roundup: C&J Energy Services, Key Energy Services
Research has shown that smaller cap stocks outperform their larger cap peers, so let's take a look at some possibly explosive picks. C&J Energy Services (NYSE: CJES) may be the winning choice. It trades at a respective 5.4x past earnings with a PEG ratio of 0.3x. Analysts are calling it a "buy." Dahlman Rose recently upped its price target to $32, a whopping 50%+ premium to the prevailing price.
Several factors make me bullish on this oilfield service provider. As natural gas prices recover, there will be a concomitant rise in domestic E&P. C&J is prepared to gain big, because it has already kept margins healthy despite industry-wide excess capacity a decline, however slight, in onshore rig count. The large producers have North American margins decline, so their clients are looking to see higher prices; C&J, on the other hand, could offer them cheaper fees because of an improved cost structure. As Global Hunter rightfully noted, contract renewals showcase "the legitimacy of CJES' growing franchise." Add in acquisitions, such as Casedhole Holdings for $273 million, and you have a company that is getting aggressive on the growth curve.
Small cap peer Key Energy Services (NYSE: KEG) is, in my view, more of a mixed bag. It trades at 13.5x forward earnings and is forecasted for only 6.7% annual EPS growth over the next 5 years. Analysts are on the fence about the stock with a "hold" rating. Assuming expectations are met, 2016 EPS will come out to $0.63. At a multiple of 15x, this translates to a future stock value of $9.47. This represents a 7% average annual return--not the kind of appreciation you want to see from a small cap stock. On the other hand, it is valued at 14% less than book value, so takeover chatter could emerge to drive up the stock price. Oil & gas is a scalable industry, and revenue synergies would theoretically steepen the growth curve and thereby create value.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!