Gloomy Outlook for Patterson-UTI

Shares of Patterson-UTI Energy Inc. ( PTEN - Analyst Report ) are currently trading close to its 52-week low of $13.66. The onshore contract dealer has seen its share price fall nearly 30% since the beginning of this year, as investors have been selling the stock for its weak fundamentals and tepid outlook. The recent cost escalation issues surrounding one of the company’s key inputs has added to this bearishness.

Patterson-UTI has approximately 330 land-based rigs that operate mainly in the oil and natural gas producing regions of North America. The company operates primarily in Texas, New Mexico, Oklahoma, Arkansas, Louisiana, Mississippi, Colorado, Utah, Wyoming, Montana, North Dakota, Pennsylvania, West Virginia and western Canada.

Additionally, Patterson-UTI is engaged in the exploration and production business and provides pressure pumping services (an umbrella term used to describe a number of vital services performed on new and existing wells).

We continue to appreciate the company for its growing premium land rig fleet and exposure to the boom in pressure pumping services (an umbrella term used to describe a number of vital services performed on new and existing wells). In particular, there is considerable tightness in the market for shale-suitable rigs, and dayrates across the rig fleet have been going up. In the near term, Patterson-UTI stands to benefit from the current boom in pressure pumping services.

Despite these positives, Patterson-UTI – the second-largest North American land drilling contractor after Nabors Industries Ltd. ( NBR - Analyst Report ) – currently retains a Zacks #5 Rank, which translates into a short-term Strong Sell rating.

This can be mainly attributed to the higher-than-expected spike in the costs for guar gum – a key constituent of the ‘hydraulic fracturing’ procedure – which is by far the largest part of the pressure pumping market.

Guar gum, a bean grown mostly in India, apart from being a dairy products thickener is also a main ingredient of the hydraulic fracturing (or fracking) process, which is used to extract natural gas by blasting underground rock formations with a mixture of water, sand and chemicals.

The demand for guar gum has gone through the roof in North America following the growing use of hydraulic fracturing in the extraction of oil and natural gas liquids from shale. This has led to concerns about the commodity’s potential shortage later in 2012, thereby driving up guar gum prices more rapidly than previously thought. We believe that the rising costs may affect Patterson-UTI’s second quarter profitability more than expected.

Moreover, with natural gas fundamentals remaining weak, we see no price upside for Patterson-UTI stock in the near-to-medium term. Plus, increased labor costs for contract drilling may put a brake on the segment’s margin expansion, which could further limit the company’s ability to generate positive earnings surprises.

Given these concerns, we expect Patterson-UTI to perform below its peers and industry levels in the coming months. As such, we see little reason for investors to own the stock.