Lone Star Technologies is More than a Pipe Dream

When Chevron (CVX) announced on September 4th that it found oil deep in the Gulf of Mexico, they were talking DEEP: 7,000 feet under water and another 20,000 plus feet under the sea floor. Have you ever stopped to think about the practicalities involved with drilling oil from this deep down? Pulling oil up that far involves thousands upon thousands of feet of pipe – and at a cost of over $500,000 a day just for the boat, labor and equipment, it better be GOOD, fault-free pipe. Enter Lone Star Technologies (LSS), a company that, after the recent acquisitions of oil pipe-makers Ipsco and NS Group, remains the only major independent US producer of oil field steel tube products.

Wall Street is buzzing about Lone Star because now as the sole independent player in the steel tubular market, it presents a perfect candidate for an acquisition. If an international steel company wants a big presence in the US, Lone Star will sit alone on the shelf.

But I like Lone Star for more reasons than just that. For one, it has a unique product. While competitors’ tubes tend to be carbon-grade, Lone Star’s tubes are high-quality, alloy-grade for use in deeper wells (think of Chevron drilling miles underground). Over 70% of its tubing sales come from premium sales. What’s more, Lone Star recently announced plans to acquire a 40% stake in a Chinese steelmaker -- Valin Steel Tube & Wire -- and to sell its seamless tubes in North America. If this sale goes through, this will expand not just its product base but improve margins, as well as give a real boost to LSS’s stock in 2007.

No doubt, Lone Star comes with risk. Some analysts are frightened by its cyclical nature -- its reliance on the volatile oil market. Additionally, it is linked not just to the oil business, but to the price of steel. If the price of steel rises, its products go up in price, which is fine when drilling is in a boom cycle. But when price of oil drops, drilling activity slows, demand for tubing lessens, and any higher cost of steel will have to be eaten by Lone Star -- and thus erode its margins.

That said, I just don’t see oil exploration dropping anytime soon. Yes, the price of oil has fallen in recent days, but I am of the mindset that this is a temporary phenomenon. Oil is a precious commodity, and I think that the recent success of Chevron in striking oil is only going to encourage more exploration.

Type of stock: A cyclical stock in the steel business, analysts worry about its over-reliance on oil drilling activity. But the chance of Lone Star being a winner -- through being acquired by an international steel company or by its joint venture with a Chinese steel manufacturer going through -- is too great for me not to take this risk.

Price target: Currently trading at $47.70, this is a pick – there is risk in this pick, but if the stars align right, we’re going to see Lone Star’s worth fly to much higher levels in 2007.

LSS 1-yr Chart

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