The near-term market softness on account of economic disruption caused by the coronavirus outbreak and the associated oil price rout presents one of the most significant challenges to the Zacks
Oil and Gas - Drilling industry. That said, a few of the drilling contractors like Helmerich & Payne ( HP Quick Quote HP - Free Report) , Transocean ( RIG Quick Quote RIG - Free Report) , Patterson-UTI Energy ( PTEN Quick Quote PTEN - Free Report) are Nabors Industries ( NBR Quick Quote NBR - Free Report) are well equipped to deal with the prevailing market headwinds driven by greatly reduced costs amid stronger operating efficiencies. Industry Overview
The Zacks Oil and Gas - Drilling industry consists of companies that provide rigs on a contractual basis to explore and develop oil and gas. These operators offer drilling rigs (both land-based/onshore and offshore), equipment, services and manpower to exploration and production companies worldwide.
3 Trends Defining the Oil and Gas - Drilling Industry’s Future In The slump in oil prices and coronavirus-induced demand shock have pushed drilling activity lower by introducing tremendous uncertainty around the exploration and production (E&P) spending outlook. From supermajors Negative Impact of Weak E&P Investment to Continue: ExxonMobil ( XOM Quick Quote XOM - Free Report) and Chevron ( CVX Quick Quote CVX - Free Report) to smaller players like Abraxas Petroleum, all have made drastic cuts to their capital expenditures in an attempt to preserve cash and stay afloat. Obviously, this translates into lesser work for the companies that make it possible for upstream players to drill for oil and gas. In a nutshell, the oil and gas drilling fundamentals remain extremely bearish with most of the companies entirely focused on survival. While oil prices have rebounded strongly from the coronavirus-induced depths, most producers will likely continue with their ongoing cost reduction efforts in 2021. With not much chance of a significant E&P capex cut reversal next year, drilling activity is expected to remain weak over the near-to-medium term. Amid the plethora of negative headlines, one of the key positive arguments for drillers is the focus on reserve replacement rate. Over the past few years, the supermajors have struggled to replace all of the oil and gas they churn out, raising concerns about future production. In this context, Chevron and Depleting Reserves to Fuel Drilling Demand: Royal Dutch Shell’s ( RDS.A Quick Quote RDS.A - Free Report) 2019 oil reserve replacement ratio of just 44% and 76%, respectively, indicates the inability to add proved reserves to the amount of oil and gas produced. This clearly calls for a calibrated approach in meeting reserve shortfalls in the long run. Consequently, a gradual improvement in drilling activity looks likely. The highly cyclical nature of the industry makes its participants — which generally build big and expensive drilling rigs — heavily dependent on the prevailing business environment. In other words, it’s extremely difficult for any driller to perform well during a commodity downturn. However, the ability to come up with technologically superior products with higher efficiency can help companies gain a competitive edge in the market. Of late, be it onshore or offshore, both groups are focusing on improving project economics on the back of lower costs and sophisticated technology. Within the industry, it's interesting to note that the volatility associated with offshore drilling companies is much higher than their onshore counterparts and their share prices are more correlated to the price of oil. But investors should keep in mind that these stocks are prone to quick falls, unlike the stocks of land drillers. Cost Efficiency to Determine Project Viability: Zacks Industry Rank Indicates Dimming Outlook
The Zacks Oil and Gas - Drilling industry is an 11-stock group within the broader Zacks
Oil - Energy sector. It currently carries a Zacks Industry Rank #194, which places it in the bottom 24% of more than 250 Zacks industries. The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates challenging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic on this group’s earnings growth potential. As a proof of this, the industry’s earnings estimate for 2020 has decreased 38.4% in the past year. Meanwhile, the same for 2021 has slumped 120.5% over the same timeframe. Despite the dim near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first. Industry Underperforms Sector & S&P 500
The Zacks Oil and Gas - Drilling industry has lagged the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.
The industry has declined 45.3% over this period compared with the broader sector’s decrease of 29.2%. Meanwhile, the S&P 500 has gained 17.1%. One-Year Price Performance
Industry’s Current Valuation
Since oil and gas companies are debt laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of non-cash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), the industry is currently trading at 14.21X, lower than the S&P 500’s 16.82X. However, it is well above the sector’s trailing-12-month EV/EBITDA of 4.94X. Over the past five years, the industry has traded as high as 16.20X, as low as 3.85X, with a median of 9.62X, as the chart below shows. Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
4 Oil and Gas - Drilling Stocks to Keep an Eye On Nabors Industries: Nabors is one of the largest land-drilling contractors in the world, conducting oil, gas, and geothermal land drilling operations. The company is well positioned with a sound mix of high-performance rigs and new rigs working in the key shale plays like Bakken and Permian. The 2021 Zacks Consensus Estimate for this Hamilton, Bermuda-based company indicates 5.1% earnings per share growth over 2020. Nabors currently carries a Zacks Rank #3 (Hold). The stock has gained 36% over the past six months. You can see . the complete list of today’s Zacks #1 Rank stocks here Price and Consensus: NBR
Helmerich & Payne: Helmerich & Payne is engaged in the contract drilling of oil and gas wells in the U.S. & internationally. Its technologically-advanced FlexRigs are much in demand and it has already upgraded most of its drilling fleet with the latest technology. The fiscal 2021 Zacks Consensus Estimate for this Tulsa, OK-based company indicates 40.7% earnings per share growth over fiscal 2020. The provider of land and offshore rigs carries a Zacks Rank #3 and its shares are up 15.6% over the past six months. Price and Consensus: HP
Patterson-UTI Energy: Patterson-UTI Energy is one of the largest North American land drilling contractors, having a large, high-quality fleet of drilling rigs. The company’s technologically advanced ‘Apex’ rigs are the key to its success. Patterson-UTI’s proprietary design makes the rigs move faster than conventional rigs, drill quicker and more efficiently. The 2021 Zacks Consensus Estimate for this Houston, TX-based company indicates 2.1% earnings per share growth over 2020. Patterson-UTI currently carries a Zacks Rank #3. The stock has gained 28% over the past six months. Price and Consensus: PTEN
Transocean: Being the largest provider of offshore contract drilling services, Transocean's unrivalled backlog of $8.2 billion offers cash flow visibility. As it is, the company’s technologically advanced and versatile drilling fleet differentiates it from competitors and provides it with an edge. Over the past 30 days, Transocean has seen the Zacks Consensus Estimate for 2021 improve 15.8%. The downstream operator carries a Zacks Rank #3 and its shares have gained 11% over the past six months. Price and Consensus: RIG