Big Upside Seen For Bronco Drilling

Every so often, a tremendous growth stock can be accumulated at prices attractive to a value investor. These companies make for some of the best investments. Bronco Drilling is one of those companies.

Bronco Drilling Company (BRNC) provides contract land drilling services to oil and natural gas exploration and production companies. They own a fleet of 64 land drilling rigs, of which 50 are currently operating, 4 are in the process of being refurbished and 10 are held in inventory.

By many common valuation metrics, Bronco is very cheap. They are trading at a trailing P/E of 8.5 and a forward P/E of only 5.73, based on today’s closing price of $17.70. The current price/ book value ratio for Bronco is only 1.37. They are trading at a trailing P/EBITDA of 4.

Ratios as low as these would catch the eye of most any value investor. A company trading at these ratios would normally be a mature or even deteriorating business. Bronco Drilling is far from being either of these. In the past 12 months, they reported revenue of $242.3 million, a more than 500% year over year improvement on the $47.6 million they reported in the prior 12 month period.

Earnings have grown at a similar clip. Earnings per share for FY 2006 are expected to come in at $2.54. Analysts are also looking for $3.09 in earnings per share for FY 2007. Yahoo! Finance shows Bronco as having a PEG ratio of 0.13, an extremely low figure.

We believe Bronco is well positioned to beat these current estimates to the upside, something this company has consistently done since their IPO a little more than a year ago. Based on management’s expectations of ending Q1 2007 with 55 rigs in operation (compared to 50 at the end of the most recent quarter), and assuming day rates increase at a rate consistent with historical increases, Bronco’s earnings should increase by at least $0.10 per share to $0.80, above analysts current estimates for the quarter of $0.79.

This $0.10 improvement is based solely on a 10% increase in operating rigs and modest increases in day rates, something that management expects pointing out that three contracts that will be renewed in the current quarter will be renewed at higher daily rates. As the rig refurbishing program slows, spending will as well, giving further potential upside to the aforementioned $0.10 improvement. Given this knowledge we are looking for Bronco to earn $0.82 per share in Q1 2007 and $3.52 for FY 2007.

The shares of most companies throughout the Oil and Gas Exploration Services industry have had a rough year, following a decline in natural gas prices. The fear of further declines in natural gas prices is overdone in our opinion, and expectations of a warm winter are already factored into current natural gas futures prices.

We feel this overreaction to the year’s declines in natural gas prices is evidenced by the fact that companies throughout the industry are trading at steep discounts to historical prices based on current P/E and P/EBITDA ratios. A reversion to the mean is anticipated therefore we are looking for P/E ratios to expand throughout the industry.

Bronco currently trades at a trailing P/E of 8.5, we view a P/E of 10 as fair value for a company in Bronco’s sector. Given Bronco’s strong growth rates, they deserve to trade at a slight premium to their peers, making a P/E of 12 justifiable for this company. By applying this multiple to our estimate of FY 2007 earnings of $3.52, we arrive at a fair value of $42.00 for shares of Bronco Drilling Company.

Also supporting our Strong Buy recommendation is a downside limited by their very low Price/ Book Value ratio relative to their peers and their strong balance sheet. A strong technical base was recently built at $17.00, a figure that we view as a bottom in Bronco’s share price. Bronco Drilling represents one of the markets most compelling investments based on our perceived risk to reward ratios.

Disclosure: The Marley Group has a long position in Bronco Drilling Company.

BRNC 1-yr. chart