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Oil Services Stocks: Ready for a Lift

By George Putnam, III
The Turnaround Letter

Ever since the collapse of oil prices that started in July 2014, when oil fell from $100/barrel to $25 companies that provide drilling rigs, equipment and related services have struggled to survive. Several have slid into bankruptcy. To make it to the eventual upturn, companies have had to slash expenses, lay off thousands of employees, shrink their capacity and do whatever else is necessary to stay afloat. Ultimately, these challenges will prove beneficial for the industry as it weeds out low-quality operators and marginal capacity, and being leaner, the survivors will be much more profitable when the upturn eventually comes.

While the growth rate of global demand for crude oil may be slowing, overall demand continues to increase. The recent downturn in oil prices was largely caused by excess supply and eventually low prices will reduce that supply enough to boost oil prices again. There are signs that the next upturn is not very far away – many U.S. wells have been shut down, and OPEC is talking about cutting production – but the oil markets are notoriously difficult to predict. Therefore, we have sought out companies that will benefit greatly when drilling activity picks up again but that have the wherewithal to survive even if the upturn is several years away. The companies below generally fit that profile. Earnings are currently depressed or non-existent, and so the P/E multiples don’t mean much, but the balance sheets are typically very strong, along with cash flow.

Dril-Quip (DRQ) focuses exclusively on manufacturing offshore drilling and production equipment. Globally diversified with manufacturing facilities in Texas, Scotland, Singapore and Brazil, the company has remained profitable throughout the downturn. Profit margins for the first half of 2016 were higher than year ago due to cost-cutting and efficiency improvements. The balance sheet is remarkably strong, with nearly $500 million in cash (almost $14/share) and zero debt.

Helmerich & Payne (HP) started in 1920, Helmerich & Payne is the world’s largest provider of high-powered, high-quality land drilling rigs – the type used in frac well drilling. With 395 total rigs, it has the largest share of the U.S. land drilling market and a large international presence. H&P also has nine offshore drilling rigs. Very well-run and conservatively capitalized with $950 million in cash compared to about $500 million in debt, the company would be a major beneficiary of higher oil and gas prices. Management recently raised its dividend, and so the generous 4.3% dividend yield appears safe.

Oceaneering (OII) is best known as one of the few companies that provide remote-operated vehicles (“ROVs”). These are robots used in water that is too deep for human divers. By no means toys, these highly complex driverless submarines rent for as much as $10,000 per day. Along with this vital service for deepwater energy drilling and production, the company provides a wide range of equipment and solutions for all phases of the offshore oilfield lifecycle. Oceaneering is supported by a reasonable balance sheet with $393 million in cash against $802 million in debt. Investors collect an an attractive 4.1% dividend while waiting for the upturn.

Oil States International (OIS) manufactures a full range of equipment for deepwater oil and gas drilling rigs, production platforms and undersea pipelines. It also has an onshore business that provides services for completing wells and producing oil and gas. In 2014, the company completed a very well-timed (at the top of oil market) spin-off of its well-field lodging business, Civeo. Oil States’ operations are global, insulating it from weakness in any one region. The company has cut costs, and it produced $64 million of free cash flow in the first half of the year. Total debt is less than $85 million, partly offset by $52 million in cash.

Weatherford (WFT) is a higher risk name. The company’s service-oriented line of business helps companies find, develop and produce oil and gas, and so its fate is closely tied to drilling activity levels. While its operations are similar to high-quality giants like Schlumberger and Halliburton, Weatherford has struggled with weak financial controls, (leading to a $140 million fraud settlement), high debt and loose spending habits. Its long running CEO has few fans among investors.

However, the company’s relatively new CFO (since 2013) seems to be cleaning up the accounting and the cost structure, and much of the debt has been refinanced and extended. While Weatherford could be more vulnerable to a prolonged downturn, the upside in the stock will be greater as long as the company is still around for the recovery.

Editor’s Note: Written for 30+ years, The Turnaround Letter, 1 year, 12 issues, $195, has a 15-year annualized return of 11.63% versus the S&P 500’s 5.29%, making it one of the top-performing investment newsletters for that period of the approximately 200 on the market today. For more information and a Special Offer visit www.TurnaroundLetter.com.


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