Oil Service Stocks: A Deep Sea Play Whose Time May Have Come

Oil has fallen tremendously. Oil service stocks have fallen more or less in sync with the price of oil. Now oil has seemingly bottomed. Some people think we have already seen the low. Some people think we may still see a further low as a result of this most recent stock sell off. Most people think the price of oil will climb for the summer driving season. Most people think oil will be higher this fall than it is right now. At the very least this means that there won’t be huge negative factors driving the oil service stocks down. The deep sea drillers as a group have huge backlogs for their rigs. They have solidly profitable contracts for several years out. They have not had huge contract cancellations, and most people do not expect that this will happen. Instead as oil recovers over the next two years they will be able to sign more solidly profitable contracts to add to their backlog. To me this means that this sector should likely be a solid investment at this point in time.

Let’s take a look at the statistics. I have included SLB as a comparison. It is a leader in oil services, but it is not generally considered a leader in deep sea drilling.

The first 6 rows of data in the tables below come from TD Ameritrade. The next 6 rows of data come from Yahoo Finance.

STOCK	RIG	NE	DO	ATW	SLB
PE	4.57	4.2	6.64	3.86	8.62
P/S	1.51	1.87	2.46	1.69	1.65
P/B	1.15	1.22	2.60	1.06	2.70
P/CF	3.39	3.35	5.45	3.39	6.1
Quick Ratio	1.82	1.83	2.78	4.10	1.35
Debt/Capital	46.19	14.87	13.07	24.51	23.81
FPE	4.02	3.64	5.51	3.00	12.34
PEG	0.43	0.28	0.30	0.14	257.2
Mean Recommendation	1.6	2.1	2.4	2.4	2.3
Current Price	$56.63	$23.00	$59.97	$14.02	$36.42
1 yr. target price	$101.72	$40.85	$85.08	$28.25	$54.35
5yr. per annum growth estimate	10%	13.48%	20%	27%	0.05%

To me virtually all of these companies seem to be good buys. RIG is clearly the most highly recommended. NE was just added to the Goldman Sachs conviction buy list. DO is the least leveraged. ATW has the lowest PE, FPE, PEG, P/B; and it has the highest Quick Ratio (ability to pay its debts) and the highest 5 year per annum growth estimate. It’s probably not one of the “Big Boys”, but it seems to have the potential to outstrip the others in growth over the next few years.

SLB was recently recommended by Cramer as a better play than ATW. I don’t see this from the numbers. However, you can’t argue with the fact that SLB has been a perennial leader in the oil service industry. I am not sure I believe its growth estimate or its PEG (I got these from Yahoo Finance). I tend to think the numbers must be better than that. However, it may lag the other stocks in performance, since it is not a pure play deep sea driller. I will stick to the deep sea drillers. I believe the industry fundamentals in this area are better. Take Cramer’s advice if you believe it.

Stock position: Long ATW.

Comments

[Correctamundo:]

Question: what kind of metric is "FPE?" What does it stand for and how is it calculated?

Mar 04 01:24 PM

[David White:]

FPE is the forward Price to Earnings Ratio. In this case it technically is the price to earnings ratio using the forward twelve months of yet to be reported earnings. It is calculated based on the average of the analysts' estimates for earnings for the company in the forward 12 months (and the current price of the stock).

However, you should be aware that many times people use a different interpretation. They use the earnings for the forward year for the FPE calculation. For instance, if the company were currently in the reporting year 2009, then the earnings estimates for the year 2010 would be used. This may not techinically be correct, but it is often used for convenience.

The current P/E is calculated based on the trailing twelve months of earnings results (and the current price of the stock).

Mar 04 02:02 PM

[toobad41:]

You are correct in your note that SLB is not a deep sea contractor. However, SLB provides a lot of geo-steering for each of these drilling companies you mentioned. In fact SLB had owned RIG before it decided to get out of the drilling contract business. If offshore drilling picks up you can be sure SLB will have a hand most of it. They have the expert knowledge of how to drill for a reservoir target.

Mar 04 03:08 PM

[David White:]

RIG is now below its lower bolinger band on its daily chart. Usually this is a buy signal. Currently the overall market is going down, which might mean you should wait to get in. However, RIG definitely belongs on your watch list. This stock may go roaring up in the very near term, if we can get even a small overall market rally.

Mar 06 11:01 AM

[Turnipseed:]

I agree the offshore drillers are oversold and should do well in the next couple of years. However, in the long run they are dependent on higher oil prices. If oil prices are stagnant for the next 2-3 years, they may be in trouble. SLB and competitors like HAL and BHI are more diversied in the services they offer, so I consider them less risky.

Mar 06 01:25 PM

[David White:]

RIG was downgraded by Morgan Stanley today. This likely accounts for its fall today. The downgrade note said there was no expectation of increased drilling rates in the near term future. That was the reason for the downgrade. Since RIG had already sold off in the last week or two prior to this, this likely makes this a good buying opportunity for RIG. It is below its bottom bollinger band on its daily chart. It is still the most highly rated deep sea driller, even with the morgan stanley downgrade. It still has both great value and great growth characteristics, especially for this difficult financial environment.

Mar 06 02:49 PM

[David White:]

Actually the timing of this downgrade I find very suspicious. It would have seemed much more appropriate when RIG was higher by more than $10. This downgrade makes me think that this brokerage is trying to profit from others fears. Specifically, they may be trying to force more people to flee the stock as their fear is high due to the recent market collapse (i.e. get an extra push downward at the end of the downward movement). Then they can buy the stock back at a lower price (or advise some of their customers to do so). Excuse me if I am a little cynical.

Mar 06 03:13 PM

[David White:]

Apparently Barron's agrees with me. They have an article out today (Mar. 6, 2009) called, "The Time Is Right For Rigs". This might provide an alternate view of the topics of this article.

Mar 06 03:42 PM

[Jude1955:]

I'm surprised Mr. White that Ocean Rig was not included in your article. I believe you are bullish on DRYS and the hoped for "Primelead" spinoff projected for the near term . ( I am a firm believer that it will indeed happen ; G. Economou has set his vision high in the UDW drilling world , as well as his banks that continue to extend credit covenants to pursue this profitable goal. Any new thoughts would be sincerely appreciated . Thanks

Mar 06 11:43 PM

[David White:]

Jude1955: I think the Primelead / Ocean Rig spin off from DRYS should do well eventually. However, nearly all IPOs have gotten hammered in the last year, so I am not optimistic in general on IPOs this year. Also when I last talked to DRYS, they told me that the spin off would not occur until 2H 2009. Thus there is not a clear cut investment in this area on Ocean Rig / Primelead as a Deep Sea Driller. Further I am waiting to see what information comes out in the DRYS quarterly report. It should be informative.

I will be interested to see how many extra shares of stock they have sold recently. They will likely say how many they intend to sell in the near future (i.e. how much dilution there will be). They should also clarify DRYS' financial health to a large degree.

I am still bullish on DRYS in general. It is at a great price, especially considering the spin off dividend of Primelead/Ocean Rig that they have promised the shareholders. This makes DRYS one of the few (or perhaps the only) Dry Bulk shipper that is actually going to pay a substantial dividend in 2009 (presuming the spin off to shareholders occurs).

DRYS is due to report soon. It may pop up if the market moves up early this week. I may play that. However, I will mostly wait to see what information DRYS provides when they report.

Mar 08 07:46 PM

[David White:]

Today FBR upgraded RIG from market perform to outperform (apparently at least partly based on its size). FBR had negative comments about land based drilling prospects, but said nothing similarly negative about deep sea drilling.

Mar 09 09:10 AM

[Jude1955:]

Thanks Mr. White , DRYS advanced well today and the BDI is keeping it's momentum , up 8 straight days!

Mar 10 04:33 PM

[David White:]

Beware: Oil prices have been rising lately on weakness in the US Dollar and on speculation that OPEC could cut production again at its meeting this weekend. What happened today may only be a prelude to what will happen tomorrow. Today oil prices started out with a rise, but they finished with a loss.

Tomorrow the Crude Inventories data comes out. If this follows the more recent pattern the inventories may be up. This could put downward pressure on oil and on oil services temporarily.

If usage has recently been trending up in the US, why do I say this?

Apparently some people have been buying oil when it goes down in price (into the mid thirties range). Then they have been storing it out on tankers in the Gulf of Mexico. They are reasonably assured that the price of oil will go up for the summer driving season, so they can afford to do this with the currently cheap tanker rates. When the price of oil moves significantly over $40, they tend to bring the ships into port (to deliver/sell the oil at that higher price). When a lot of people do this at the same time, this tends to drive the price of oil down. Then these same people are able to buy more oil in the mid thirty dollar range. The cycle repeats.

Eventually the summer driving season will be here. Then these same people will not have the assurance that they can likely sell their oil for significantly more than they bought it for. This practice may stop. Also these same people would likely be taking a bigger risk during "hurricane season" (and possibly paying more for insurance). We will have to see what happens.

Further the EIA decreased its estimates for the average price of oil for this year and next. The average price this year is now estimated at $42/barrel. It had been estimated at $43. EIA lowered its forecast for 2010 from $55 to $53. Decreased demand was cited at the reason for these decreases. This probably accounted for much of the loss in oil futures.

This all may keep the upsurge in oil service stocks at bay for a day or two more. In fact if the fall in oil prices today is followed by a larger fall tomorrow, that may be enough to cause the S&P500 to fall (it is an oil heavy index). The DJIA would likley follow it. I am very cautious about tomorrow. There was a lot of euphoria about the dramatic rise today. However, other people are pointing to another looming credit crisis, especially a credit card crisis. There is also the increasing default rate on loans to the emerging growth countries (and on home and commercial loans) to worry about. I am very circumspect heading into tomorrow.

Mar 10 05:51 PM

[David White:]

As I expected the crude inventories rose. Ditto the distillate inventories. However, the gasoline inventories fell. All told this was negative for oil as the market had been expecting a significant draw down. However, the market has seems to shrug this off. USO is currently up from about $27 to $27.65. This should put the deep sea driller paly back on track as long as the markets cooperate. Most of these stocks are still very near their bottom bollinger bands. As long as the market cooperates, they should rise. Of course, that's a big "IF".

Mar 11 11:15 AM

[David White:]

More Good News (DJ):The Conoco CEO said he sees oil moving up to $60 to $70 per barrel.

News such as this should help the oil service stocks rally.

Mar 11 11:58 AM

[Jude1955:]

On another note Mr. White in reference to Tullow Oil (the company on contract with the Erik Raude drillship...one of DRYS rigs) has made a significant oil discovery in the Jubilee Field off the coast of Ghana. The contract extends to 2011 with options of renewal at the end of March. Almost 700K per day in revenue for Dryships ...I can see a good bounce in oil price this summer and of course....ship valuation ,freight pricing and drilling rigs will rise in tandem ...

Mar 11 12:20 PM

[David White:]

On the overall market performance: There is some speculation that we may currently be in a bear market rally. The SPY is currently at $72.33. I see resistance points at approx. $75.5, $78, and $80.5. It seems likely the market will turn down at one of these points if the premise of a bear market rally is valid. Of course, there is no saying this won't occur sooner. Many of the bank stocks have turned around today (notably BAC and WFC). Of course, investment banks such as MS and GS are still doing well today. This may be a good sign for BAC, which now has Merrill Lynch.

USO has also turned very negative. This is likely bad for the deep sea drillers stocks trade to the upside. It may wear off after a day or so though. OPEC does meet this weekend. They may decide to cut production further, which would buoy oil prices. That would be good for this trade. An end of the week rally in oil may occur.

Mar 11 01:11 PM

[David White:]

The oil futures rallied so much today that I am not sure what they will do tomorrow. The Price of a barrel of oil was up more than 10% today. The IEA releases world demand figures tomorrow. These will likely show a decrease in demand. I think the deep sea driller rally has further upside, but it may take a rest tomorrow.

Mar 12 04:20 PM

[Jude1955:]

New contract today between Shell/Petrobas for 3 years with Dryships.....650M !! Glad I stayed long and maintained my optimism with DRYS !!

Mar 19 02:30 PM

[drbob66:]

OK, I realize I'm a little late to the party here, but I'm hoping maybe someone is still following the drillers and I'm a little confused. The avg. 2009 EPS estimate for ATW is $3.67 (low est. $3.09)...and for 2010 it's $4.43 (low est. $3.80). This is (with either estimate, avg.or lowest) a projection of 20% growth rate...yet the stock is trading at $22. This is 6.1x 2009EPS estimates (7.3x lowest EPS est.)...and only 5-6x 2010 EPS estimates. Seems awfully cheap to me. Am I missing something here? Do these drillers always trade at a low multiple, or what?

Apr 19 07:13 PM