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:
Drilling operators think that the lessons learnt during the bust years will help them undertake sizeable expenditures, while maintaining the target capital structure. With the onshore players greatly reducing costs amid stronger operating efficiencies, most of the projects are likely to generate decent returns even at today's oil prices. The lower breakeven and attractive project economics are leading to more onshore projects being sanctioned. The good news is most exploration and production companies have plenty of cash to invest. A tight leash on expenditure and conservative spending plans have resulted in cash flow coming in at higher rates, driving onshore spending and drilling activity.
On the contrary, recovery in oil prices has 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 improving 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, one of the key positive arguments for offshore drillers is the focus on reserve replacement rate. With less oil being discovered on land and a number of upstream operators depleting their reserves fast, capital is moving into offshore projects. In fact, supplies from offshore fields are expected to be the primary contributor in meeting reserve shortfalls in the long run. There is just no alternative.
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 Bleak Outlook
The Zacks Oil and Gas - Drilling is a 13-stock group within the broader Zacks
Oil - Energy sector. The industry currently carries a Zacks Industry Rank #172, which places it in the bottom 32% of more than 250 Zacks industries.
Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dim 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. In fact, the industry’s earnings estimates for 2019 have decreased 128.3% in the past year.
Despite the bleak 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 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 42.7% over this period compared with the broader sector’s decrease of 14.3%. On the contrary, the S&P 500 has gained 14.5%.
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 non-cash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), the industry is currently trading at 8.10X, lower than the S&P 500’s 11.51X. However, it is significantly above the sector’s trailing-12-month EV/EBITDA of 4.82X.
Over the past five years, the industry has traded as high as 13.01X, as low as 4.07X, with a median of 8.06X.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio
Steadiness of oil prices at the current levels is driving operators to make longer-term plans, as projects (especially the deepwater ones) become cost effective if taken up for a long term. Consequently, demand for offshore drilling services have picked up. 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. Nevertheless, structural oversupply and pricing pressure will weigh on the sector constituents’ operating margins.
Despite the downbeat mood in the industry, we are presenting a stock with a Zacks Rank #2 (Buy) that is well positioned to gain amid the prevailing challenges. There are also three 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 (Strong Buy) stocks here. Parker Drilling Company PKD: This company – a provider of onshore and barge drilling services to the global energy industry – has seen the Zacks Consensus Estimate for 2019 increase 56.9% over the past 30 days. Parker Drilling carries a Zacks Rank #2. Price and Consensus: PKD
Patterson-UTI Energy, Inc. ( PTEN Quick Quote PTEN - Free Report) : Patterson-UTI is one of the largest onshore contract drillers in the United States and has a large fleet of pressure pumping equipment. The company carries a Zacks Rank #3 and has an excellent earnings surprise history having surpassed estimates in each of the last four quarters, the average being 32.6%. Price and Consensus: PTEN
Noble Corporation plc NE: This company is an offshore driller with a fleet of 25 jackups and floaters. The Zacks #3 Ranked Noble has an expected earnings growth of 10.3% for this year. Price and Consensus: NE
Helmerich & Payne, Inc. HP: Helmerich & Payne is engaged in the contract drilling of oil and gas wells in the United States and internationally. The company carries a Zacks Rank #3 and has an excellent earnings surprise history having surpassed estimates in each of the last four quarters, the average being 41.2%. Price and Consensus: HP