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Helmerich & Payne (NYSE:HP) provides contract drilling services in the US, Argentina, Columbia, Ecuador and Venezuela. The company owns and operates 156 U.S. land rigs, 9 U.S. platform rigs, and 27 international rigs. This conservatively managed company has shown operating earnings through previous good and bad oil price cycles over the decades. It maintains a very solid balance sheet with ample cash and marketable securities. The well-covered dividend represents just a 4.2% payout ratio. Company executives draw very reasonable pay packages unlike many industry peers.

Helmerich's earnings tend to move in tandem with oil prices and have risen substantially since bottoming in FY 2003. (FYs end in September). Here are the (split adjusted) per share numbers from the past six complete years as reported by Value Line:

…………………………………………………………........ Avg.

FY …… Sales ….. C/F ….. EPS ……. B/V ….... Div…... P/BV

2003 ….. 5.14 ….. 1.00 …. 0.18 …… 9.15 ….. 0.16 … 1.53x

2004 ….. 6.19 ….. 1.30 …. 0.36 …… 9.12 ….. 0.16 … 1.59x

2005 ….. 7.70 ….. 1.94 …. 1.02 ……10.38 …. 0.17 … 2.31x

2006 …..11.79 …. 3.81 …. 2.77 ……13.30 …. 0.17 … 2.26x

2007 …..15.74 …. 5.17 …. 3.50 ……17.54 …. 0.18 … 2.00x

2008 …..18.53 …. 5.35 …. 4.23 ……20.88 …. 0.18 … 2.39x

I have noted the average annual price/book value as opposed to the average P/E because of the earnings volatility related to oil pricing.

At yesterday's quote of $21.40, the shares trade at just 1.02x book value - their lowest valuation by that measure since oil last bottomed in 1998 – 2000. The current P/E is just 5.1x actual trailing earnings of $4.23 and 5.3x projected FY 2009 EPS of $4.04 which assume oil prices stay well under year ago levels.

Except for the past few weeks, HP shares had not traded below $21.30 since the middle of 2005 – a year when FY EPS came in at $1.02 versus last FY's $4.23. These shares are only cheap now because oil has fallen to $38.30 as I'm writing. If you feel we'll see higher oil prices in the future this looks like a good way to play the future price rebound.

If HP shares return to even their lowest average price/book value [1.53x] from the years 2003 – 2008… they would hit about $38 based on expected year-end book value of near $25. That would only be a P/E of 9.4x on the consensus view. Value Line is using a 12 multiple for its 3 – 5 year target projections on this company.

Is it reasonable to think Helmerich & Payne shares could hit $38 in a year? It peaked at $32.80 in 2005 on one quarter of the current EPS and at $40.20, $46.30 and $77.20 during calendar years 2006, 2007 and 2008 respectively. Unless you see oil prices in a dramatic and sustainable decline these shares stand out for future stock performance.

If you're option savvy and want a medium term play that takes a lot of risk out you might want to consider this 13 month combination trade:

……………………………………..….. ....Cash Outlay ……….Cash Inflow

Buy 1000 HP @ $21.40 …………..……. $21,400

Sell 10 Jan. 2010 $25 Calls @ $4.90 ………………………….. $4,900

Sell 10 Jan. 2010 $25 Puts @ 8.40 …………………………….. $8,400

Net Cash Out-of-Pocket ………………… $8,100

At expiration date (Jan. 15, 2010) if the shares are above $25 or up 17% from our starting price:

  • Your shares will be called (sold) for $25,000.
  • Your $25 puts will expire worthless (a good thing for you as a seller).
  • You will own no shares.
  • You will have no further option obligations.
  • You will have $25,000 for your $8,100 net out-of-pocket investment.

What's the risk here?

If HP shares are less than $25 on expiration date, you will be forced to buy an additional 1000 shares. Your net cost on those shares would be:

The $25 strike price less the $8.40 per share put premium = $16.60 /share.

Your break even on the originally purchased shares would be:

$21.40 less the $4.90 call premium = $16.50 /share.

Thus in a worst case scenario you would end up owning 2000 shares at an average cost basis of $16.55 or 22.6% below the starting price of $21.40.

At $16.55 these shares would be only 80% of book value and 3.9x trailing earnings. Both those metrics are screamingly cheap based on all recorded history for HP shares.

Summary:

If HP rebounds by 17% or more in the next 13 months you will make better than a 208% cash-on-cash return (not including dividends).

If HP shares fall by less than 22% you will still be profitable.

This represents a very good risk / reward from my perspective.

Disclosure: Author owns shares and is short puts on HP.

Source: Helmerich & Payne: Winning a 'Rigged' Game