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We have upgraded our recommendation on contract drilling services provider Helmerich & Payne Inc. (HP - Analyst Report) to Neutral from Underperform, reflecting a balanced risk/reward profile.

Incorporated in 1940, Helmerich & Payne is engaged in the contract drilling of oil and gas wells in the U.S. and internationally. The company supplies drilling rigs, equipment, personnel and camps on a contractual basis to explore and develop oil and gas from onshore areas and from fixed platforms, tension-leg platforms, and spars in offshore areas.

Helmerich & Payne’s contract drilling business consists of three reportable business segments: U.S. land drilling, offshore drilling and international land drilling.

Helmerich & Payne is a major land and offshore drilling contractor in the western hemisphere, having the youngest and most efficient drilling fleet. The company specializes in shallow to deep drilling in oil and gas-producing basins of the U.S. and in drilling for oil and gas in international locations.

We believe Helmerich & Payne’s technologically-advanced FlexRigs are the key to its success, helping to increase its count of active rigs and maintain relatively strong daily-rate margins even during the times of market uncertainty. The company’s proprietary FlexRig design makes the rigs move faster than conventional rigs, drill quicker and more efficiently, and allows for a safer operating environment.

As such, these are better suited for the new demands of the exploration business and therefore, command higher dayrates and utilization than rigs from other land drillers.

The company’s modest capital expenditure requirements and strong balance sheet have been real assets in this highly uncertain period for the economy. Leverage is low with a debt-to-capitalization ratio of 6.1% as of June 30, 2012.

Helmerich & Payne has always been extremely conservative with the allocation of capital and the use of leverage on its balance sheet. This not only helped insulate the company during the recession, but also led to the generation of $434 million in profit last fiscal year, despite volatile prices, credit restrictions and seizure of rigs by the Venezuelan government.

However, weak natural gas fundamentals and the challenging international operational scenario remain areas of concern. The glut in domestic gas supplies still exists, with storage levels remaining significantly above their five-year average. This will continue to weigh on natural gas prices in the near-to-medium term. Helmerich & Payne, which specializes in shallow to deep drilling in gas producing basins of the U.S., remains particularly exposed to this situation.

Finally, we expect investor sentiment toward the company to remain lukewarm, considering Helmerich & Payne’s below par dividend yield and miniscule payout.

Given these concerns, we see Helmerich & Payne shares performing in line with the broader market. Our new long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating), in line with its rig contractor peer Patterson-UTI Energy Inc. (PTEN - Analyst Report).

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