When Precision Drilling Trust (PDS) announced Wednesday morning that it was cutting distributions in favour of strengthening its balance sheet and reducing debt, it re-confirmed for everyone with a stake in the drilling services sector that times are getting tougher by the day, thanks to bottom barrel commodity prices and the slowing economy.
The 70% cut in Precision's distribution from C$0.13 to C$0.4, drove shares in the company down C$0.13 or just less than 2%. Not bad on the surface, maybe, but Tuesday the stock fell almost 8% and since mid-June, when it was hovering around C$28, the stock has fallen about 75%.
Large-sized selloffs like this have become common place over the past year for almost all drilling companies, large and small, working either in the oil & gas sector like Precision or in the mining space.
According to Michael Mills, an analyst with Beacon Securities who covers five drillers focused on mining exploration, weakness in the market will continue well into 2010.
Mr. Mills said in a note to clients:
The new reality is that the current drilling industry is facing a severe downturn. Rigs have been idled, crews sent home, and customers just are not sure when, if, or to what extent they will drill in 2009.
He told clients that the 2009 drilling outlook remains cloudy, with many large mining firms yet to commit specific drilling plans for the year.
For the few contracts out there that are up for grabs, the analyst said buying power has shifted into the hands of the drilling customers, resulting in a highly competitive bidding environment.
There is no longer any ability to apply day-rates and per metre rates under pressure. We believe the end result will be much lower than the currently forecast gross margins across the industry.
Mr. Mills does not expect any of the company he covers to escape the downturn, and suggests investors stick with names that are positioned best to benefit on the other side of an economic recovery.
He consider Major Drilling Group International Inc. (OTCPK:MJDLF) as his top pick, rating the stock a "buy" with a reduced price target of C$15, down from C$23 previously.
Its clean balance sheet, sustainable dividend, operational size and scale, and conservative management puts MDI in a position to capture new business when the sector improves.
Mr. Mills also likes Energold Drilling Corp. (OTCPK:EGDFF) as his top small cap pick. He maintained his "buy" rating on the stock and reduced his price target from C$2.50 to C$1.75.