High Reward Oilfield Service Stocks To Potentially Buy

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

Though natural gas prices have been on the decline, unconventional shale gas is expected to see soaring demand. Investors have been largely focused on the short-term negative catalysts, such as a weak pressure pumping environment, overcapacity in oil basins, and decreased land drilling. This great deal of industry risk makes it reasonable to look at producers with the highest upside for investment opportunities. Below, I consider 1 takeover target and 2 small cap stocks.

Weatherford (NYSE: WFT): A Prime Takeover & Activist Target

Activist investors are known for taking large stakes in beleaguered companies and then lobbying for change to unlock value. Weatherford, an oilfield service supplier, has lost more than a quarter of its value for the year to date off of issues related to internal control. When a company has struggled with its own corporate governance, it makes it much easier for an activist investor to convince shareholders to replace the board with representatives. If nothing else, it adds pressure on management to listen to the activist lest a new board come in and boot the CEO. It should not be surprising that Dan Loeb's Third Point has disclosed a 0.5% stake in the company--he is the same investor that earlier targeted a Yahoo board shakeup to much success.

How vulnerable is Weatherford to an activist attack? First, there are the corporate governance woes. 16.2% in value was erased in recent months after management announced in the 3Q12 earnings call that accounting problems are likely to cause a "growing sense of unease and alarm"--the company will have to go back and restate previous numbers. Second, stock returns have materially underperformed the market, often substantially in the 3,000 bps range, over the last 6 month, 1 year, 5 year, and 10 year periods. Third, S&P recently downgraded the credit rating to just one notch above "junk". Fourth, the company is regarded as a takeover play by virtue of its compelling price, global footprint, and attractive product lines. While consistent insider buying helps deter a campaign, these four factors, when strung together, are enough, in my view, to generate a successful activist campaign.

Activists are ultimately value positions and reserve costly proxy campaigns only when they have levers that could catalyze the stock price. Weatherford trades at 6% below book value and is forecasted or a sharp recovery from the $0.88 per share that was lost over the twelve trailing months. Just a few days ago, Deutsche Bank reiterated its "buy" and called Weatherford a $21 stock, which is nearly double what it currently trades at. Halliburton and Baker Hughes are both in need of improving margins, and greater scale through a takeover could help the company spread out fixed costs while gaining value from the appreciation of an undervalued target.

Small Cap Roundup: C&J Energy Services (NYSE: CJES) Vs. Tesco Corporation (NASDAQ: TESO)

While I believe Weatherford is a pretty solid takeover and activist play, there are higher returns to be found in the small cap space. C&J and Tesco represent two opportunities. The former trades at only a respective 5.6x and 7.1x past and forward earnings and, despite running 33.5% from the 52-week low, is still not seeing its growth forecasted in, as evidenced by the 0.28x PEG ratio. Analysts are very optimistic on C&J and go so far as to rate it a 1.9 out of 5 where "1" is a "buy." Dahlman Rose, the analyst that is also calling Weatherford a possible "takeover," has a $32 price target on C&J, which is a ~50% premium to the prevailing price.

Tesco has struggled a bit in recent months. 2Q12 revenue of $136.7 million missed expectations by $13 million while 3Q12 EPS of $0.23 missed by a stunning 6 cents. The lack of positive catalysts makes me particularly concerned that an investment in Tesco could be no better than its oilfield service pears. At 12x forward earnings, the company is relatively expensive.

Analysts expect Tesco to only grow EPS by a rate of 8% over the next 5 years. Combined with the likely of a contraction in the multiples, it’s hard to see a scenario where Tesco will actually outperform Weatherford and C&J. Although there has been a slight reversal since November, shares have been trending downwards over the last six months.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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