Does Precision Drilling Belong in Your Portfolio? (Part II)

See part I here.

As I stated earlier, Precision Drilling (PDS) has been on a tear recently, nearly all in the negative direction. Sitting at about $2.00 a share, is it a good value? With a quick look at its fundamentals, I would say yes. But is it a good investment? That is the real question. Here in Part II we will analyze the not so great part of Precision's business, the part that has driven its stock price down nearly 90%.

In late 2008, Precision completed the highly competitive and controversial takeover of Grey Wolf. Grey Wolf had originally agreed to a merger with Basic Energy Services (BAS). Grey Wolf rejected the Canadian driller's advances via a public statement two days after the Precision bid was publicly disclosed. Precision then had to follow up with a second, more expensive offer. The offer price was only hiked a bit more than 3%, but they had much more favorable terms pertaining to the cash and share swap ratio. Precision then took it one more level with its third and supposedly final offer of $10/share. Precision's bid at that time for GW alone was valued at about $1.97 billion. Value of the combined companies as of March 2009: $370 million. That obviously means that Precision has been left with a life threatening debt load.

For 2008, PDS generated an average operating cash flow of $270 million dollars. Not bad. Throw in the debt load however and that turns into a leveraged cash flow of $-88 million. A bit scary considering their return on assets, operating margins, gross profits, and overall revenues will drop precipitously in 2009, and possible well into 2010. The point of this buy-out was to gain more exposure and market share in the United States drilling arena, expanding out from Canada. Seems like they may have extended too far on the way up, and are now possibly overleveraged on the way down.

If you are worried about Precision's chance of survival with those stats…it gets worse. To make the acquisition of Grey Wolf, Precision inherited a bridge loan to pay for the buy-out. These loans are normally short-term as they charge a very high interest rate. Basically, they are used to get financing quick, then they are repaid for refinancing through the issuance of shares or a debt offering. Tough luck for PDS. With a balance sheet choking for air and a credit market just as squeezed, Precision was forced to postpone their offering of $172.5 senior notes, the ones that were supposed to refinance the bridge loan. If they can’t peak up enough interest in this offering when they try again, they are stuck with a gigantic 17% loan. Having $48.5 million in cash seems petty when they have a staggering $1.12 billion in debt. That’s with a $370 million market cap, pegging them at an enterprise value of about $1.5 billion.

Conclusion: There is no doubt in my mind that this industry will have its day in the sun yet again. The question is however: will they make it? After reviewing PDS, I believe this company is more of a bet than an investment. You are betting on multiple things; Can they restructure their debt, can they keep their contracts, how long will the downturn in energy last? It comes down to one question. Can they survive? If you bet correctly, it’s a multi-bagger. If not, you lose everything. Unless you feel lucky or know something that others don’t about this stock, I’d stay away. Some other stocks that are worth looking into include ATW, RIG, and HERO. HERO has many of the same characteristics but I believe ATW and RIG will be able to weather the downturn, but have much less upside than smaller, more troubled stocks like PDS.

May all your investments flourish.

Disclosure: no positions

Comments

[BudaBobNu:]

Avoid PDS. The GW purchase was not good for PDS.

Mar 05 12:29 PM

[Chris B:]

Why is it that this website spends hours examining the most hopeless, speculative companies, while overlooking the better investments? I mean, I gawk at car wrecks too, but this is ridiculous. How many articles do you see about longshot cases such as C, BAC, WFC, GS, JPM, GM, F, etc?

Why aren't we analyzing BNS, USB, RIG, VLO, HMC, TTM, TMB, AMX, EWY, EWZ, EWA, NFLX, RHT, ORCL, etc? Why spend hours examining the companies that won't survive this recession? Are we investors, or gawking bystanders?

Mar 05 03:05 PM

[Ryan Vanzo:]

Thanks for your comments and I see where your coming from but there should always be room for more risky stocks. At first glance PDS would probably seem like a great value. After deeper research it's glimmer fades to a soft rusty tone. I definitely agree that this stock might not make it out of the recession. But you do not know that unless you know something about the company, which is what this research is.

Every stock you research should NOT come out as a good investment. Only a select handful of companies should be worthwhile. Most of the stocks you look into should have a conclusion like this one, because they are not all great investments.

I see most of the stock you (Chris) have listed are big name best of breed businesses such as BNS and USB. How many times have you learned that the best in breed always fall down once people realize they aren't much different that the others...that they are all affected.

It is easy to say that F, C, and BAC are bad investments, but tell me when you made your USB call. I guarantee you thought it was a great buy at a much higher price than it is now. You mention TTM as well. I would like you to write a research article on it for seekingalpha because you will probably find that they have just as many problems as PDS, some just in different forms.

The stocks you have listed as bad have a community sentiment as being bad stocks. The ones you stated are good, most people would say they were good. Don't just assume these things, dig deeper, write an article, prove your point.

Mar 05 11:30 PM

[bassmaster17:]

RIG has some charactoristics of a monopoly amongst smaller competitors, which is why it should trade at a premium relative to them. Morgan Stanley needs to become a real company before it downgrades one.

Mar 06 11:38 AM

[User 373891:]

Love to hear your opinion on HERO and PCX.

Kevin

Mar 10 08:55 PM

[Ryan Vanzo:]

I believe both HERO and PCX are in roughly the same position as PDS, especially HERO. I think both will be fantastic trades as long as they don't go bankrupt. Deep research is needed exploring their books and debt obligations to determine the chances of this happening.

If you would like an official analysis written up on either I would be glad to do that for you.

Good Luck,
Ryan Vanzo

Mar 11 07:14 PM

[PeteK:]

PDS will be fine.
Canada needs it.

Apr 09 02:42 AM

[PeteK:]

Ryan,
You did a good job answering those comments.
We really appreciate your effort.
To me, PDS is the PRIDE of Canada.
People there love the company.
Just as many Americans love GM.
But of course not as bad as GM right now.
When a company has the confidence of the people,
it will be OK down the road.

Apr 11 05:08 AM