On Mar 19, 2013, we upgraded onshore contract driller Nabors Industries Ltd. (NBR - Analyst Report) to Neutral from Underperform. Our new investment thesis is supported by a Zacks Rank #3 (Hold).

Why the Upgrade?

With leading positions in most natural gas and oil-based shale plays, Nabors is a big player in the North American land drilling market. The company reported better-than-anticipated December quarter profits last month and also recently announced that it will start paying quarterly dividends.

Detailed Analysis

Nabors, which ranks ahead of Patterson-UTI Energy Inc. (PTEN - Analyst Report) as the largest North American onshore contractor, has a large, high-quality fleet of drilling and workover rigs. Over the years, the company has grown through cash flow reinvestments and acquisitions. In the process, Nabors has not only increased its rig fleet, but also extended its geographic reach and diversified its operating assets beyond land rigs.

Barbados-based Nabors reported fourth quarter 2012 non-GAAP earnings per share of 30 cents on Feb 19, beating the Zacks Consensus Estimate of 29 cents by a penny. Results were driven by strong operational execution.

We welcome Nabors’ recent announcement to start paying out a portion of its earnings in the form of shareholder dividends. We believe that the dividend start-up not only highlights Nabors’ commitment to create value for shareholders but also underlines the energy equipment supplier’s confidence in its business going forward.

However, we remain concerned about weak natural gas fundamentals, which are likely to limit the company’s ability to generate positive earnings surprises. Nabors’ fairly debt-heavy balance sheet also remains an issue.

Stocks That Warrant a Look

While we expect Nabors to perform in line with its peers and industry levels in the coming months and advice investors to wait for a better entry point before accumulating shares, one can look at Helmerich & Payne Inc. (HP - Analyst Report) and Tesco Corp. (TESO - Snapshot Report) as good buying opportunities. These oil and natural gas drilling equipment suppliers – sporting a Zacks Rank #1 (Strong Buy) – have solid secular growth stories with potential to rise significantly from current levels.