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On Nov 1, 2013, we downgraded onshore contract driller Nabors Industries Ltd. (NBR - Analyst Report) to Underperform from Neutral.

Why the Downgrade?

Based upon the number of near-term challenges, we see Nabors as a risky bet that ordinary investors should exit.

Detailed Analysis

Barbados-based Nabors conducts oil, gas and geothermal land drilling operations and is the largest land-drilling contractor in the world. It is also one of the largest land well servicing companies and workover contractors in the U.S. The company offers a number of ancillary wellsite services, including oilfield management, engineering, transportation, construction, maintenance, well logging, and other support services in select domestic and international markets.

We are concerned about the weakness in Nabors’ pressure pumping business. Deterioration in pricing and utilization, coupled with the spike in costs, is likely to adversely impact the company’s near-term results. The depressed North American onshore rig count has also been a negative.

As usual, we remain worried about weak natural gas fundamentals, which are likely to limit the company’s ability to generate positive earnings surprises. The glut in domestic gas supplies still exists, with storage levels remaining above their five-year average levels.

This will continue to weigh on natural gas prices in the near-to-medium term. Nabors – the largest North American land drilling contractor ahead of Patterson-UTI Energy Inc. (PTEN - Analyst Report) – remains particularly exposed to this situation since its business in the region is heavily biased to gas drilling.

Nabors’ relatively weak balance sheet in this severe credit-constrained environment (debt-to-capitalization ratio of approximately 41%) is also a cause for concern. Over the last few years, the company kept adding debt to its balance sheet for a fleet recapitalization program.

Stocks That Warrant a Look

While we expect Nabors to perform below its peers and industry levels in the coming months and see little reason for investors to own the stock, one can look at Matador Resources Co. (MTDR - Snapshot Report) and Northern Oil & Gas Inc. (NOG - Snapshot Report) as good buying opportunities. These domestic upstream energy operators – sporting a Zacks Rank #1 (Strong Buy) – have solid secular growth stories with potential to rise significantly from current levels.
 

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