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Nabors Industries Ltd. (NYSE:NBR) is the largest drilling contractor in the world with a fleet of 501 land based rigs, 743 land well servicing rigs, 40 offshore platforms, 12 jack up rigs and 4 barge rigs. The stock has been quite volatile in the past few days, trading in the $12.50 and $15.00 range, which is slightly above the $11.05 low that the stock hit in October 2011.

Profits have steadily declined since 2006, and the company actually lost money in 2009 reporting a net loss of $85 million. As the company attempts to return to profitability amid stabilizing earnings, it may be a good time to re-examine the Nabors story.

Overall growth picture

From the table below, we see that though operating revenues are higher in comparison to 2008, operating costs have increased at a faster rate resulting in a lower operating profit margin. Net profit margin has also been steadily declining and was a dismal 4% in 2011 as compared to 8.8% in 2008 and around 18% in 2005 and 2006.

Revenue
(in thousands)

2011

2010

2009

2008

Operating revenues

6,116,998

4,167,750

3,506,788

5,201,677

Operating Costs

4,265,856

2,739,239

2,402,996

3,537,142

Operating Profit (%)

1,794,495

1,395,244

1,259,224

1,857,083

Operating Profit Margin

29.61

33.75

34.38

34.43

Net Income

243,679

94,695

-85,546

475,737

Net Profit Margin (%)

3.97

2.27

-2.42

8.82

Business Segments

Nabors categorizes its operations as Contract Drilling, Pressure pumping, Oil and Gas Exploration and Production, and Other operating Segments. The contract drilling segment comprises of drilling, workover and well servicing in United States, Canada, Alaska, international operations and offshore activities. Hydraulic fracturing and downhole surveying services are included in the Pressure Pumping operating segment, while the oil and gas exploration, development and production operations are included in the Oil and Gas operating segment. The other operating segment houses operations like drilling technology and top drive manufacturing, directional drilling, rig instrumentation and software and construction operations.

Here is a revenue distribution from each of the segments:

Operating Revenue(In thousands)

2011

2010

2009

Contract Drilling

4,379,679

3,525,334

3,420,236

Pressure Pumping

1,237,306

321,295

-

Oil and Gas

59,685

18,657

-182,654

Other Operating Segments

674,206

427,154

417,531

A further segmentation of the Contract drilling operations tells us where the real growth is coming from:

Contract Drilling - Operating revenues

2011

2010

YoY Growth

U.S. Lower 48 Land Drilling

$1,698,620

$1,294,853

31.18

U.S. Land Well−servicing

$701,223

$444,665

57.70

U.S. Offshore

$170,727

$123,761

37.95

Alaska

$129,894

$179,218

-27.52

Canada.

$574,754

$389,229

47.66

International.

$1,104,461

$1,093,608

0.99

What is very obvious from these numbers is that the heightened activity in US Land drilling is contributing to growth. The pressure pumping services, which grew by 300% within a year, could turn out to be the real joker in the pack for Nabors.

Oil and Gas Exploration and Production detour

Since 2007, Nabors forayed into exploration, production and development activities in the United States, Canada and Colombia. Given the complex and risky nature of the exploration business, the ride has definitely been rocky for Nabors and it has announced plans to totally exit this segment. Pursuant to this, the company sold off certain assets in 2011, which resulted in a cash inflow of around $303 million. However, current and non-current liabilities of $125 million still exist on the balance sheet with regards to these discontinued operations.

Nabors has 17.7 MMBbls (millions of barrels) of proven liquid reserves and 607.6 Bcf (billions of cubic feet) of proven natural gas reserves in its oil and gas portfolio, which it values at around $400 million. Obviously, this valuation is much dependent on the oil and gas prices in the international market.

Backward integration of its business would have seemed lucrative to Nabors back in 2007, but with the benefit of hindsight we can say that this was a strategic mistake and it has lost quite a bit of money and focus from its core business activity in this detour. The drilling and the exploration business are both correlated to the market price of oil and gas, and hence this backward integration does little to mitigate the ups and downs of the business brought about by price volatility. All in all, we must say that it is a good move to get out of this segment for Nabors and shift the focus back on the core business.

Declining Rig Fleet

Another serious concern for Nabors is the decrease in number of rigs in its portfolio. The table below puts things in perspective:

Type of Rigs

2011 count

2010 count

2006 count

Land Drilling Rigs

501

550

600

Land well−servicing

743

727

780

Offshore platform

40

37

43

Jackup Rigs

12

13

19

Barge Rigs

4

3

3

In 2011, the company recorded a provision of $98.1 million for decommissioning and retirement of one jackup rig, 116 land rigs and a few land well servicing rigs because they were "functionally or economically non-competitive for today's markets". To address this concern, the company has outlined a capital expenditure of $1.5-$1.7 billion for rig-related enhancements, new construction and equipment.

Future Earnings

The diluted EPS from continuing operations for Nabors was 83 cents for the year 2011. Extreme volatility in earnings has been a characteristic feature for Nabors given the recurring nature of non-recurring events. On a standalone basis, it becomes very difficult to forecast the earnings even for the immediate future, given the asset sales and writedowns from discontinued operations that Nabors will make in this year. Hence it makes sense to value Nabors in comparison to its peers. The table below compares the PE ratio of Nabors and its competitors:

Trailing P/E (ttm)

Nabors Industries Ltd.

14.57

Industry

11.16

Patterson-UTI Energy Inc. (NASDAQ:PTEN)

6.64

Ensco plc (NYSE:ESV)

12.96

Helmerich & Payne Inc. (NYSE:HP)

9.68

Yahoo finance

Among the group compared above, Patterson has the lowest P/E - which is much below the industry average of 11.16. There are companies like Helmerich and Payne (click here for detailed report on Helmerich and Payne) that engage in similar business activities, have a business focused in areas just like Nabors, and have stable earnings. Relatively speaking, Nabors may seem to be a good bet for the risk-loving investor, but for the ordinary investor, Nabors definitely is not a stock to invest in.

Source: Nabors Industries: A Bet For Risk Lovers