These are momentous times in the North American drilling industry.
On Monday, natural gas prices soared some 10% from a decade-low after key producer Chesapeake Energy (CHK) said it would cut its drilling of wells containing only natural gas by half, shifting resources to shale plays yielding the much more profitable crude and other liquids.
The cuts are far short of what would be needed to curb the epic glut threatening to overwhelm the nation’s gas storage capacity later this year. Yet President Obama is expected to promote natural gas drilling as the solution to America’s energy and job deficits in tonight’s State of the Union Address.
Meanwhile, US crude output is already booming, thanks to advances in extracting oil from rocks with “fracking” and horizontal drilling. The Energy Information Administration expects oil output in the continental US to jump 20% between 2010 and 2020, according to its latest upgraded estimate.
As with any resource boom, the real moneymaker here is to sell shovels to the prospectors. In this case, the shovels are land rigs, and contract driller Helmerich & Payne (HP) is the leading supplier and operator of such rigs in the continental US.
Moreover, it makes the most technologically advanced rigs in the industry, ones better adapted to the technical difficulties of shale drilling. As a result, HP can charge significantly higher day rates and enjoy fatter margins than rivals like Patterson-UTI (PTEN) and Nabors Industries (NBR), and still provide a better value proposition, thanks to its rigs’ increased efficiency.
These advantages are manifest in the 25% revenue surge HP delivered in November, as well as the 46% jump in profits. The company has more cash than debt, and is valued at an attractive 12 times estimated earnings for the current fiscal year, and less than seven times trailing cash flow.
Roughly three-quarters of its rigs are drilling for oil and natural gas liquids, as opposed to “dry” gas, so shifts such as the one announced yesterday by Chesapeake play to HP’s strengths. Revenue days for its land-based rigs, a key demand metric, are forecast to rise 5% sequentially in the most recent quarter.
Goldman Sachs opined last month that “owing to the shale revolution, US land rig demand has just entered the second phase of a multi-year pick-up.”
Even if exploration and drilling stall, many of the outdated land rigs pressed into service during the first stage of the boom are due to be retired and replaced. Goldman thinks the long-overdue recovery in natural gas prices could spur demand even more a couple of years down the road.
HP is run by the grandson of a barnstorming pilot who founded the firm 92 years ago. The founder’s son and longtime CEO, who passed away two weeks ago, was a revered civic leader in Tulsa, Oklahoma.
That death spurred profit-taking in the stock—probably on worries about sales by insiders, who haven’t been shy in the past about unloading at levels near the current one.
But this is an inexpensive stock with a dominant competitive position in a booming industry, stable and skilled leadership, and very bright prospects. The profit taking seems to have run its course following yesterday’s intraday reversal. HP is headed higher.