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Healthy Growth Outlook for Oil & Gas Drilling Industry

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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.

Let’s take a look at the industry’s three major themes:

  • Oil prices have rallied almost 40% since hitting a 17-month low of $42.53 a barrel on Christmas Eve. Consequently, work for drillers – particularly onshore – has picked up again. With the ongoing momentum, there appears to be more room on the upside for oil prices. Again, thanks to the emergence of major shale plays yielding impressive results over the last few years, there has been an overwhelming requirement for complex drilling. This has led to huge demand for new premium land rigs. The positive crude narrative coupled with the shale drilling frenzy has helped prop up the growth prospects for land drillers.
     
  • On the other hand, recovery in oil prices have not led to significant activity for offshore drillers. The three-year price slump has forced the top energy companies to cut spending (particularly on the costly drilling projects) due to lower profit margins. This, in turn, has meant less work for the beleaguered drillers as offshore exploration for new oil and gas projects are nowhere near the pace of rising oil prices. With old contracts rolling off, the companies are either getting rigs stacked or bear high reactivation costs and accept much-reduced dayrates. As a result, overall revenues are impacted. However, steadiness of oil prices at the current levels is driving operators to make longer-term plans, as deepwater projects become cost effective if taken up for a long term. This could increase demand for offshore drilling rigs.
     
  • The highly cyclical nature of the industry makes its participants – who 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. Within the industry, it's interesting to note that 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 too, unlike the stocks of land drillers.

Zacks Industry Rank Indicates Sunny Outlook

The Zacks Oil and Gas - Drilling is a 14-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #89, which places it in the top 35% 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 impressive 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.

Before we present a few stocks that you may want to consider, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags 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 19.7% over this period compared to the S&P 500’s gain of 5.1% and broader sector’s increase of 0.5%.

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 noncash expenses.

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, the industry is currently trading at 9.18, lower than the S&P 500’s 10.99X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 5.33X.

Over the past five years, the industry has traded as high as 14.37X, as low as 3.93X, with a median of 7.14X.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

 

 

 

Bottom Line

With the energy sector emerging from the crude slump and debt-driven overhaul, renewed interest in the drilling space is finally raising hopes for the industry’s recovery. But even if commodity prices improve, structural oversupply and pricing pressure will weigh on the sector constituents’ operating margins.

However, sector consolidation, adoption of superior technologies, new operational systems’ optimization of the fleet by strategic sell-offs and acquisition, seeking profitable collaborations, among other strategic strides, will certainly help boost future prospects of the drilling companies. While one does not expect the sunny days of the drilling industry to return immediately, signs of recovery can definitely be seen.

We are presenting two stocks with a Zacks Rank #2 (Buy) that are well positioned to grow. There are also a few stocks with a Zacks Rank #3 (Hold) that investors may currently hold on to.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Helmerich & Payne, Inc. (HP - Free Report) : This Tulsa, OK-based company is engaged in the contract drilling of oil and gas wells in the U.S. and internationally. Helmerich & Payne, which carries a Zacks Rank #2, has an expected earnings growth of 1,064.3% for FY 2019.

 

Price and Consensus: HP

 

 

Key Energy Services, Inc. (KEG - Free Report) : Based in Houston, TX, Key Energy is an onshore drilling and well-servicing contractor providing a complete range of services. The Zacks #2 company has an expected earnings growth of 32.2% for 2019.

 

Price and Consensus: KEG

 

 

Nabors Industries Ltd. (NBR - Free Report) : This Hamilton, Bermuda-based company conducts oil, gas, and geothermal land drilling operations and is one of the largest land-drilling contractors in the world. Nabors Industries, which carries a Zacks Rank #3, has an expected earnings growth of 35.7% for 2019.

 

Price and Consensus: NBR

 

 

Independence Contract Drilling, Inc. (ICD - Free Report) : Based in Houston, TX, the company provides onshore drilling services with its premium rig fleet. Independence Contract Drilling, also having a Zacks Rank #3, has an expected earnings growth of 129.4% for 2019.

 

Price and Consensus: ICD

 

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