Some Thoughts On Oil Well Service Stocks
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 looking to profit off of natural gas prices recovering from a trough, don't just buy upstream producers--buy their suppliers as well. Oilfield service companies have multiples that are an irrational discount to broader indices, so I expect it to outperform from this wave of unrecognized growth. With that said, to find the specific winners in the industry I recommend looking at geographical expansion opportunities and recent contracts to get a sense of the corporate strategy. Below, I review thee oilfield service stocks with this consideration in mind.
Buy Halliburton (NYSE: HAL) Now
At only 10.7x past earnings and a PEG ratio of 0.6x, Halliburton is a "steal." It is forecasted for 19.3% annual EPS growth rate over the next 5 years--enough that multiples would have to plunge to 6.4x for the stock price to hold steady over this half decade. Moreover, it is creating actual value with growth, as revealed by the 18.7% return on invested capital. This ROIC is also notably 844 bps greater than the industry average. 22 of 31 analysts calling the stock a "buy," and better yet--none call it a "sell."
There are several reasons to be optimistic about the oilfield services company. First, we are seeing a wave of contracts that indicate Halliburton's strong client base. In just late November, Dialog Group, a company in Malaysia, signed a $1.2 billion contract to boost oil production in the eastern region of the country. In addition, I like the company's strategy of stacking up inventory and cutting labor costs instead of chasing market share in a low margin environment. Perhaps most importantly, the market is way too bearish on North America, which Halliburton has one of the highest exposures to in its peer group. For now, a slowing drilling market (there has been an 18% y-o-y in domestic on-land natural gas rigs) and oilfield crowding may limit margins, but this is a trough and not a "new normal". It would be one thing if the market's price suggested it was a low, but that's, again, not the case. Halliburton is valued at around a 28% discount to its historical 5-year average PE multiple.
And while there is pricing pressure and high guar costs in North America, international business has offset much of the impact. International EBIT grew 5% in the third quarter, and management has a strong focus on increasing expansion into these areas, particularly Latin America, Brazil, and Mexico. Management has also guided for continued margin expansion in the Eastern Hemisphere. Perhaps most importantly, management has reiterated its view that natural gas will be the largest driver of future energy demand growth. As a whole, margins will go up.
Schlumberger and Weatherford are two other oilfield service companies to be bullish about. Schlumberger, at 17.5x past earnings, trades below the historical 5-year average 19.6x PE multiple. Analysts forecast 16.5% annual EPS growth over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $7.75. At a multiple of 16x, this translates to a future stock value of $116.25. This makes for a 7.5% average annual return when you factor in dividend yields. While I don't expect the company to outperform, I think this return is large enough to merit an investment.
Furthermore, the company is positioning itself for secular changes. Its JV agreement with Cameron to develop products targeting the sub-sea oil & gas market has made several analysts bullish. It's not hard to see why. These reservoirs have been long regarded as storing almost mythical amounts of oil resources--tapping into that demand represents a meaningful catalyst for a challenging fracking environment. Lastly, the company has 70% of its business abroad, so it is even more hedged against domestic headwinds.
And then there's Weatherford, which, at a 20% discount to book value and a PEG ratio of 0.6x, looks like it can unlock significant value following the resolution of the Macondo oil spill. But the Street is generally more reserved on this company, with 14 of 29 analysts calling it a "hold." Moreover, a return on invested capital of 3.4% indicates that the firm is destroying value. The oilfield service provider is also highly levered compared to peers with a quick ratio of 0.86x and a long term debt to capital ratio of 40x (versus 23.7x for the industry average.) I thus recommend buying Schlumberger.
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!