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:
• The twin shocks of coronavirus-forced demand contraction and the OPEC oil price war have triggered a deterioration in the energy market environment. The price of U.S. crude fell to $19.27 a barrel at one point recently, its lowest since 2002, while Brent crude dropped below $23 – levels not seen in 17 years. With oil prices not enough to support profitable operations, most E&P operators are scrambling to cut costs and stay afloat. As customers drill fewer wells, the demand for contracting work is set to take a hit. This puts a great deal of pressure on drilling margins and utilization.
• In particular, things are looking bleak for the offshore oil sector, which was among the hardest hit by the 2014 downturn as well. The sharp price sell-offs reflect their inability to get sufficient daily rates in the current situation. 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 Healthy Outlook
The Zacks Oil and Gas - Drilling is an 11-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #58, which places it in the top 23% 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 bullish 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.
Taking into consideration the positive 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 83.3% over this period compared with the broader sector’s decrease of 49.5%. Meanwhile, the S&P 500 has lost 8.1%.
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 7.43X, lower than the S&P 500’s 9.76X. However, it is significantly above the sector’s trailing-12-month EV/EBITDA of 3.73X.
Over the past five years, the industry has traded as high as 13.22X, as low as 4.02X, with a median of 8.32X.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio
The near-term market softness on account of the latest oil price rout presents one of the most significant challenges to drilling contractors. That said, a few of them are well equipped to deal with the prevailing market headwinds.
Sector consolidation, adoption of superior technologies, new operational systems’ optimization of the fleet by strategic sell-offs and acquisition, profitable collaborations, among other strategic strides, will certainly help boost future prospects of the drilling companies.
For the offshore players, greatly reduced costs amid stronger operating efficiencies are likely to generate decent returns for most of the projects even at today's oil prices. As a matter of fact, the lower breakeven and attractive project economics are leading to more offshore projects being sanctioned.
With the abovementioned catalysts set to provide near-term upside, we are presenting two stocks with a Zacks Rank #2 (Buy) that are well positioned to gain. There are also two stocks with a Zacks Rank #3 (Hold) that investors may currently retain.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Precision Drilling Corporation PDS: This company – Canada’s largest drilling rig contractor – boasts a solid earnings surprise history having surpassed estimates in each of the last four quarters, the average being 106.3%. Precision Drilling carries a Zacks Rank #2.
Price and Consensus: PDS
Noble Corporation plc NE: This company is an offshore driller with a fleet of 25 jackups and floaters. Zacks #2 Ranked Noble has an expected earnings growth of 11.2% for this year.
Price and Consensus: NE
Nabors Industries Ltd. NBR: Nabors Industries is one of the largest land-drilling contractors in the world, conducting oil, gas, and geothermal land drilling operations. The company carries a Zacks Rank #3 and has an expected earnings growth of 35.6% for 2020.
Price and Consensus: NBR
Helmerich & Payne, Inc. HP: Helmerich & Payne is engaged in the contract drilling of oil and gas wells in the U.S. 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 59.1%.
Price and Consensus: HP