Introduction: Helmerich & Payne (HP) is my favorite energy stock. I believe that management is highly competent, honest, and motivated to achieve long-term success. The company is the direct successor to a company formed in 1920 (thus I jokingly think of it as the "real" HP) by a Helmerich. The current CEO, Hans Helmerich III, is thus fully aware of not only the difficult times in the oil patch in the 1980s, but the more difficult times in the 1930s. He intends HP to have the resiliency a company operating in the highly cyclical field of oilfield services has had to have to survive, and thrive, continuously for 93 years.
I reviewed the company in some detail on March 15, 2013, in a Seeking Alpha article titled Helmerich & Payne Continues To Gain Market Share. Readers who are unfamiliar with HP's history and innovations may wish to read that article either now or after this one; that article also has links to appropriate parts of HP's own web site.
That article opined that HP's price was probably ahead of itself even though the company was doing well. That was a good call. HP closed March 15, at $66.26, above where it is as I write this. That has occurred despite strong operating performances and a major boost in the dividend from 7 cents one year earlier to 50 cents quarterly.
Facing sluggish conditions in its main business segment, contract drilling for oil and gas on land in the U.S., HP continues to face headwinds. However, its high dividend yield now makes me much more interested in holding this equity while waiting for business conditions to improve.
In addition, I hold out hope that HP could at any time break out upward through an evolving triple top chart pattern, and move toward the upper end of its historical valuation range even before profits move toward new record territory.
Corporate background: HP is an integrated technology-driven designer, manufacturer, and operator of "FlexRigs" that drill for oil and gas. The focus is on unconventional formations, such as those exploited via fracking techniques. HP is well ahead of its competition with this line of rigs. This is how it describes itself on its web site:
H&P owns and operates land rigs in the U.S. and in various international locations and offshore platform rigs in the Gulf of Mexico. The Company endeavors to deliver well cost savings to its customers through ongoing improvements and leadership in drilling efficiency and safety. Its success is based on its ability to develop and apply new ideas, technologies and processes that create a differentiated, high-quality service offering. As a result, H&P has been able to deliver unprecedented drilling performance and value to its customers.
The company is in the process of leaving an intensive period of capital spending behind. Thus, it was able to increase its dividend from 7 cents to 50 cents quarterly. Due to its long history in the industry, years ago it found itself owning many shares in major oil producers and drillers. Over the years, it has been monetizing those assets. Last quarter, it sold half its remaining shares in Atwood Oceanics (ATW) for $200 MM, and sold nearly one million shares of Schlumberger (SLB). The company is now increasingly liquid, with strong working capital ratios and minimal long-term debt relative to assets. With capital spending declining, HP may be in a position to return increasing amounts of capital to shareholders, of which Mr. Helmerich appears to be the largest individual one.
The company is in this favorable position because it has led the transformation of U.S. land drilling by introducing AC drive technology to drilling rigs via FlexRigs. Older technologies are losing favor. HP projects that even if the land drilling rig count remains static, it will continue to gain market share within that space, even if it loses some share within the AC rig sector to the competition. HP's website explains some of its advantages over the competition in some detail. (The Howard Weil presentation from March is the best introduction to the topic rather than the more recent June investor meeting slides.) These advantages allow high operating margins. Essentially, HP has a continuing first-mover advantage in its main field of drilling rigs for unconventional oil and gas formations.
Earnings pattern and valuation history: HP has been an earnings powerhouse, keeping pace with the industry leaders. On a per share basis, earnings, sales, cash flow, and book value have all grown in a low to mid-teens rate over both the past 5 and 10 years.
Going back more than 10 years and since it spun off its production subsidiary in 2002, HP has tended to trade at 1.5-3X revenues per share, 5-10X cash flow, 1.5-3X book value, and perhaps 7-15X current-year earnings. It has exceeded these at extreme times, including on the high side as oil soared near $150/barrel in H1 2008, and on the low side after oil's price collapsed after Lehman's bankruptcy. During periods of low oil prices early last decade, before unconventional oil and gas deposits became widely exploited, cyclically low earnings were accompanied by very high P/Es, however.
Currently, HP has a trailing 12-months P/E of 9, but part of those GAAP earnings reflects the large gain on the securities sales last quarter. Current consensus earnings estimates for its 2013 fiscal year are around $5.56, so the P/E on operations is about 12X. Value Line estimates that on a per share basis, HP's full-year ending book value will be $39.25, cash flow $10.00, and revenues $31.85. In the aggregate, these are about average, unchallenging valuations for HP.
My bias at this point is that relative to the average stock, HP is relatively undervalued.
After all, HP has superior products, allowing it to sport a superior balance sheet. It's operating in a field that once again is exciting, the redevelopment of the United States' oil and gas reserves - which it has helped enable. HP's operating margins were about 41% last fiscal year; direct competitor Nabors' (NBR) were about 28.5%. HP's net profit margins were about 18% vs about 7% for NBR, even though HP had a higher tax rate. HP carries a much lighter debt load than NBR, helping to account for its superior net profit margin.
Future prospects and competition: The company believes that it can get more efficient and grow market share. From Seeking Alpha's conference call transcript:
David Wilson - Howard Weil Incorporated, Research Division
First, just wondering on rig efficiencies and how much is left out there? Is it just a matter of the industry more fully deploying the best rigs or more pad drilling or is there something else? And do these efficiency gains mean we can expect kind of an acceleration of the older, more legacy rigs maybe to the sidelines sooner rather than later?.
Hans Christian Helmerich - Chairman of The Board and Chief Executive Officer
But the bar just gets placed higher and higher and as you have more horizontal drilling, more well complexity, John talked about even in the Permian, if you had told us that we'd have had the market share made up from Flex 3s and now Flex 5s in the Permian, it just speaks to, Dave, what your question is getting at. So I think the performance bar is higher and that really suits us well. I also think, when you look at our performance, our efficiency capture, based on footage drilled, has gone up considerably. Last year, over the previous year, year-to-date, it's up an impressive number as well. So... we keep finding ways to improve our performance.
In addition to market share growth prospects, the CEO alluded to what are tentative growth prospects in areas such as the Middle East. Currently, ex-U.S. is not a growth area for HP. In a few years, that's an upside possibility that might be significant.
One of the other comments from the conference call that I liked was this from the CEO:
I do think that we're focused on the type of returns we're generating, and again, we believe that the market is improving. So we thought it was ill-advised for competitors to try to deeply discount even their top-tier rigs just in order to try to capture some activity. The delta between our activity today and theirs is still significant.
That comment struck me as a gentlemanly put-down of the competition.
The impression I got from listening to this conference call was that this is a knowledgeable, confident CEO who believes that he holds a trump card or two. HP's FlexRig utilization rate is about 92% in the U.S., and it continues to build new rigs at a rate of two per month; about 246 FlexRigs are active now in the U.S. The CEO is being patient and is waiting for the market to come to him. He is not going to begin, or join, a price war.
An important downturn in oil pricing would therefore clearly harm the stock.
Technical considerations: All the relevant moving averages are in gear. As of July 15, 7.6 MM shares had been sold short out of 107 MM shares. That provides at least some fuel for an accelerated stock price move should the land drilling market turn up. The pattern being traced involves a high at $77 in 2008, when the drilling market was very tight and oil's price was spiking; a second high in the ebullient days of 2011 just over $73; and the current move, which reached the high $60s just after earnings were released. The long-term chart looks like this:
They say there are few triple tops; that they usually give way to new highs. The stock is getting close, though it's not quite there yet.
The long-term chart is impressive, showing a regular pattern of surges and setbacks. It would show an even sharper acceleration if one adjusts for the significant spin-off of HP's production operations in 2002.
I get the feeling that it's just a matter of time for HP to enter all-time high territory. However, because commodities overall remain in the downtrend that began in 2011, I am cautious about the timing. Of course, one cannot know until it actually happens.
Risks: HP could be forced into a price war should the price of oil drop sharply. A competitor could unveil impressive competition against HP's FlexRigs. Argentina or an other foreign country could expropriate HP's assets there. Tax rates could rise overseas or in the U.S. The stock market could drop sharply. Fracking could be regulated more harshly than expected. The stock market could decline, taking HP with it.
The above are, of course, only some of the risks to investing in this stock.
Summary: Decades of investing in individual stocks have led me to believe that where there is continuity of management of a leading, innovative, financially-strong company in an important business segment, it pays to be long the stock.
I look at HP as a cyclical gem that individual investors may wish to consider for inclusion in their portfolios.
Disclaimer: Not investment advice; I am not an investment adviser.