These 3 Undervalued Oil Stocks Have Takeover Potential

Includes: GE, NBR, VTG, WFT
by: Hawkinvest

A recent drop in the price of commodities including oil has put pressure on many stocks in this industry. After a recent pullback, a number of stocks in the oil sector are now trading at undervalued levels, and some of these companies even have takeover potential.

Merger and acquisition activity has been strong in 2013, and many companies either have cash on the balance sheet that is generating almost no returns, or have the ability to easily borrow to fund an acquisition at very low interest rates. Also, there is a general improvement in some key areas of the economy such as housing. Positive signs of an economic recovery are serving as a catalyst for companies to make acquisitions before asset prices rise further, or before a competitor moves first to announce a deal.

The oil sector has seen its share of takeovers and just recently General Electric (NYSE:GE) agreed to buy Lufkin Industries (NASDAQ:LUFK) for about $3 billion. Announcement of this deal caused Lufkin shares to surge by about 40% in a single day, and that was great news for shareholders of this oilfield equipment maker. General Electric could be poised to make additional acquisitions in the energy sector. A recent article in USA Today details what GE is strategically targeting and it states:

GE is putting particular focus on oil and gas, hoping to capitalize on the boom in extracting oil from difficult places, such as deep offshore, shale formations under several U.S. states, or older depleting oil fields. GE bought Wellstream, a maker of flexible pipes for gathering oil undersea, in 2010, and a division of the John Wood Group, a maker of pumps and control systems, in 2011.

Of course, there are many other companies that have made recent acquisitions in the oil sector or plan to do so in the future. While it does not make sense to buy a stock solely on hopes of a takeover, it can be very rewarding if it happens. It does make sense to buy undervalued stocks in this sector which have recently experienced a pullback, especially when there are upside catalysts with or without a takeover deal. With this in mind, here are a handful of companies that could be attractive acquisition targets, but also have short-term rebound potential and long-term upside even without a deal. Here are some undervalued oil stocks to consider now:

Weatherford International Ltd. (NYSE:WFT) provides offshore drilling services to many of the world's largest oil and gas companies. As demand for offshore drilling is expected to grow, Weatherford appears well-positioned in the coming years. This stock appears undervalued and that is why some industry-watchers believe that Weatherford could be a takeover target. As a recent article points out, the price paid by GE valued Lufkin at about 17 times Ebitda, while Weatherford currently trades at just over 7 times Ebitda. The article goes on to say:

The transaction implies that Weatherford, Lufkin's closest competitor, is undervalued and also may be an appealing takeover candidate, said Laurence Balter, chief investment strategist at Oracle Investment Research, which owns Weatherford stock.

Even prior to the General Electric deal, some analysts speculated that it would buy Weatherford. Now that GE has agreed to acquire Lufkin, a deal for Weatherford seems less likely, at least for GE. However, there are other large companies that could see Weatherford as an acquisition target.

One reason that may have caused GE to pass on a deal for Weatherford is because this company has experienced accounting issues that required restatements, and it is being investigated for possibly violating the Foreign Corrupt Practices Act. The company has also had charges that have impacted financial results in recent quarters. Disappointing and inconsistent earnings reports combined with the accounting and investigative issues appear to have kept this stock in the penalty box for awhile. However, if the company successfully resolves these issues, the stock appears to have upside as it trades close to book value which is $11.55 per share, and for around just 13 times earnings estimates.

Here are some key points for WFT:
Current share price: $13.17
The 52 week range is $10.85 to $18.33
Earnings estimates for 2013: 89 cents per share
Earnings estimates for 2014: $1.33 per share
Annual dividend: none

Vantage Drilling Company (NYSEMKT:VTG) is a offshore drilling firm that fits the profile of a possible takeover target for a number of reasons. First of all, it has a modern fleet that includes three ultra deepwater drillships, one "Bassoetech" drillship, four "BMC 375" jackup rigs, one ultra deepwater drillship (under management), and two jackups which are also under management contracts. I recently wrote an article about why it might be time to buy Vantage, but I also want to point out that this company could be a prime takeover target.

Vantage has nearly $503 million in cash and about $2.74 billion in debt. That is a significant debt load and a risk factor. This has been weighing on the stock and profits for the past few years. However, the company has been managing the debt load and it appears to be at an inflection point whereby major new contracts for drillships are starting to add significant growth potential for revenues and profits, which makes the debt very manageable.

The company recently added the Titanium Explorer to its fleet which is expected to generate about $572,000 per day in revenues. It also expects to launch the Tungsten Explorer in 2014 at a rate of $641,000. This is why analysts expect revenues to surge from less than $500 million in 2012, to $681 million in 2013, to around $850 million in 2014. That is expected to fuel big gains in earnings from just 6 cents per share in 2013, to 34 cents in 2014, and 42 cents in 2015. This company appears to be at a turning point and that could make it a very attractive takeover target.

Vantage was founded in 2007 and as such, it has one of the most modern fleets in the world. Newer equipment is typically more efficient and less prone to maintenance issues or mechanical failure. There are a number of major offshore drilling companies that have a much older fleet and buying Vantage could provide a "re-fresh" and lower the average age for the existing fleet. With Vantage expecting to turn profitable this year, and with double-digit growth potential and a young fleet, this could be an ideal time to buy Vantage while the stock is still cheap. It now trades below book value, which is around $1.90 per share and for just about 5 times forward earnings estimates. Compare that to the average stock in the S&P 500 Index (NYSEARCA:SPY) which trades for about 16 times earnings and for around two times book value.

Now while the debt has been holding back profits, that could also be poised to turn into a positive. The junk bond market has seen high demand, and this has pushed rates down significantly. Since Vantage is expected to experience major growth in profits and revenues, it could be a prime candidate to refinance some of its existing debt. Since this company has about $2.74 billion in debt, a 2% decrease in the interest rate could drastically lower expenses. Those numbers imply a potential cost savings of over $50 million per year, and since Vantage has around 300 million shares outstanding, that could add nearly 20 cents per share in earnings.

Furthermore, a larger company like Noble (NYSE:NE) or Transocean (NYSE:RIG) could also see that buying Vantage would make sense, because these companies have easy access to the debt markets and can borrow at much lower rates when compared to what Vantage pays now. Buying Vantage and paying off existing higher-rate debt could yield major profits, and that is another reason why Vantage seems to be an ideal buyout target. The company could soon announce a contract deal for the tungsten Explorer in the coming weeks, as well as strong results for Q1. These catalysts could be enough to create a breakout in the stock and take it above the current 52-week high of just $1.95.

Here are some key points for VTG:
Current share price: $1.70
The 52 week range is $1.32 to $1.95
Earnings estimates for 2013: 6 cents per share
Earnings estimates for 2014: 34 cents per share
Annual dividend: none

Nabors Industries, Ltd. (NYSE:NBR) also provides a wide range of services to the oil and gas industry. This includes drilling, fracking, engineering, transportation and other services. It has one of the world's largest fleets of land drilling rigs, and it is well-positioned to benefit from the growth in fracking in the United States. (It currently has around 500 drilling rigs.)

This stock was trading around $18 (in February), but a recent pullback has created a solid buying opportunity for investors with a long-term view. At about $15, these shares appear undervalued. It is trading significantly below book value which is around $20.47 per share. Nabors has a solid balance sheet which reduces risks for investors. It has about $778 million in cash and around $4.38 billion in debt. Analysts expect the company to earn $1.15 per share in 2013 and $1.53 for 2014. That puts the price to earnings ratio at just about 10 times 2014 earnings.

Nabors is also considered to be a potential takeover target. Not long ago, this company was listed as a top takeover target in a report by Morgan Stanley. The bullish view is based on a long-term trend of higher energy prices and a economic rebound. The company seems mindful of the takeover potential, and it has taken steps to protect shareholders under a rights plan, in the event of a hostile bid. The company is also working with "Pamplona Capital" which disclosed an 8.8% stake in Nabors, earlier this year. Pamplona Capital apparently finds this stock undervalued, and it is pushing for management to unlock and create shareholder value. This could also become another upside catalyst for the stock.

Here are some key points for NBR:
Current share price: $15.66
The 52 week range is $12.40 to $22.73
Earnings estimates for 2013: $1.15 per share
Earnings estimates for 2014: $1.53 per share
Annual dividend: none

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: I am long VTG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.