Nabors Should Capitalize On Strong Natural Gas Demand

| About: Nabors Industries (NBR)

Oil and gas exploration is not going to slow down any time soon. Nabors Industries Ltd. (NYSE:NBR), which offers contract drilling services, can easily capitalize on this demand.

Nabors, registered in Bermuda and headquartered in Barbados, is the largest land and platform oil, gas and geothermal drilling contractor in the world, with a 20-24% market share. As of March 2006, Nabors operates in the US, Canada, the Middle East, Australia, South America and Africa by owning or operating a fleet of 3 barge rigs, 19 jack-ups, 28 marine vessels, 43 platforms, 588 land drilling rigs and 781 land workover rigs. Nabors is the largest rig owner and operator in the US. Nabors has operations in a lot of international markets and is very diversified geographically, thereby diluting the impact of geopolitical events.

A large portion -- a little more than 90% -- of Nabors' revenue comes from contract drilling services, while the remainder comes from other services like oil field management, engineering, transportation and logistics services.

For the past five years, Nabors shares have appreciated 150% while Exxon Mobil (NYSE:XOM) shares have appreciated 50%. Since NBR listed in February 1991, its shares have appreciated 650% while XOM has appreciated 400%. Nabors is included in the S&P 500. In August, Nabors announced plans to repurchase $500 million worth of common shares. Nabors shares, on September 15, closed at 30.06, near a 52-week low, providing a good buying opportunity. With a trailing 12-month [TTM] P/E of 11 and a forward P/E of 7, the shares are very attractive. Taking TTM values and comparing them to its peers, Nabors' P/E is lower, P/S is lower, EPS is higher, sales growth is higher and ROI is lower. In 2004, revenue was $2.39 billion and in 2005 revenue was $3.55 billion. Analysts' average estimates of revenue for 2006 and 2007 are $4.88 billion and $5.95 billion, respectively. Nabors' balance sheet shows strong cash flow, revenue and growth, indicating financial strength. Nabors has a strong management capable of taking the company through ups and downs.

In the first quarter of 2006, day rates for American land drilling rose by $1,475 per day to $18,695 and cash margins rose by almost $1,000 a day to about $9,600. This was a record high. In the second quarter of 2006, day rates rose by $1,491 per day to $20,186 and cash margins rose by $1,257 per day to $10,858, again a record high. Most of the existing contracts were negotiated in 2005. Some of the contracts expire before the end of 2006, and many more will expire in 2007. When the contracts are renegotiated, there is a high probability that Nabors will be able to demand longer contracts and higher day rates, which would boost revenues without a significant increase in costs and also decrease earnings volatility. Over the long term, demand for contract drilling is expected to increase in the US as well as abroad. With rig supply limited, day rates for drilling are expected to increase, especially in international regions where Nabors will have more pricing power.

Demand for oil and gas is increasing all over the world, and drilling has been relatively shallow so far. In the case of natural gas, reserves below 15,000 feet of the earth’s surface remain largely untapped. Future exploration will concentrate on drilling wells below this level. To maintain the current natural gas production of 18.5 Tcf (Trillion Cubic Feet), more than 15,000 wells must be drilled (a conservative estimate). In the US alone, proven conventional gas resources are estimated at 192 Tcf. Of these resources, only 1% of them are deep wells. As of June 2006, the US Department of Energy (DoE) estimates that US onshore and offshore deep reservoirs hold 169-187 Tcf of gas resources. The DoE also estimates that for ultra-deep wells, drilling the last 10% of the well alone will consume 50% of the total cost. As deeper and more complex wells are drilled, total expenditure on rigs will also increase. All of this creates an advantage for Nabors.

Oil and gas exploration is not going to slow down any time soon, especially natural gas. Companies are trying to figure out future energy supplies and are spending a lot of capital on these goals. As reserves drop below normal levels, drillers have to drill deeper holes. Nabors, which offers contract drilling services, can easily capitalize on this demand. It is not easy to change drilling contractors and if Nabors has enough pricing power, which it has, it can command higher rates.

Oil and gas prices have come down from their recent peaks. But they still are high. If prices keep dropping, they will pull down the entire oil and gas sector, resulting in reduction in contract drilling day rates. But if they remain high for the next couple of years, Nabors stands to benefit, providing a strong upside.

The bottom line is that exposure to international markets, new contracts and a bullish natural gas sector provide a huge growth opportunity for Nabors. If this trend continues, Nabors stock will not stay in this price range for long. On the other hand, high drilling costs may lead producers to reduce capital expenditures on new drilling, which would hurt Nabors’ growth rate and cause the stock to remain stagnant.

NBR 1-year chart:

Disclosure: Author has no position in the securities mentioned in this article.

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