3 Strong Buy Oil Service Stocks With 30% Or More Upside

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 |  Includes: BHI, NOV, SLB
by: Takeover Analyst

Investors looking to outperform the market in a period of deepening macro uncertainty ought to consider firms that have already factored the worst in. Oil well service providers, despite delivering stronger-than-expected performance, are substantially discounted at this point. Part of the reason why the industry is undervalued stems from the Macondo spill, which has been overblown and not acknowledged as a singular event.

Analysts are currently bullish about National-Oilwell Varco (NYSE:NOV) and Schlumberger (NYSE:SLB) and mildly optimistic about Baker Hughes (NYSE:BHI). I believe all of these companies are well positioned to outperform broader indices under current growth projections. NOV is currently rated an 8 out of 10 on MSN Money's StockScouter and has a $91.80 price target on the Street according to FINVIZ.com. In fact, HSBC Securities initiated an "overweight" price target of $97 on the firm. Moreover, as can be seen below, there are no analysts who find the stock overvalued.

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Current analyst ratings for BHI. Source: FINVIZ.com.

Analysts currently anticipate double-digit growth over the next five years. Moreover, expectations have been too low over the last four quarters by an average of 7.4%. If 2013 EPS is $6.77, as expected, and grows 13.2% over the near term, as expected, 2016 EPS will be $9.82. That translated to a $137.48 future value at a 14x multiple and an $85.36 present value at a 10% discount rate. It should be noted that the company's historical 5-year average P/E multiple is 13.7x (so my exit multiple is reasonable), and the current P/E multiple is half of the industry's (so it has more room to expand than shrink). While my $85.36 price target means nearly 30% price appreciation, I still find even more attractive upside in other industry players.

Baker Hughes, for example, trades at a respective 10.2x past earnings versus 12.0x for NOV despite forecasts for greater growth and the presence of a higher multiple. The company has a PEG multiple of 0.61, indicating that growth has indeed been nowhere close to fully appreciated. If the firm realizes a 2013 EPS of $4.40 and grows 16.6% annually in the near-term as expected, the future stock value in 2016 will be $97.72 under a 14x multiple. A discount rate of 10% would place the present value at north of $60 for more than 50% upside. It would take an absurd 20% discount rate to justify the company's current valuation at $17.7B.

Part of the reason why the oil well service industry is so undervalued stems from the singular Macondo incident and another part stems from the speculation that declining energy places will curtail exploration. Performance has been more shaky than peers with an 8.3% miss in 4Q11 preceded by a 2.5% miss in 3Q11, but the loss of nearly 50% of shareholder value over the last 12 months has been out of touch with reality.

A similar long story can be presented about Schlumberger. The firm fell by "just" 25% over the last 12 months and currently trades at a respective 17.2x and 12.6x past and forward earnings. It too has a PEG ratio below 1 and double-digit growth forecasts. Performance has been more or less in-line with consensus over the past five quarters but there is still room to improve stability. As it stands, the company's current P/E multiple is worth four-fifths of the historical 5-year average (20.3x) and well below the 5-year high P/E multiple (27.5x). At the same time, Schlumberger also has excellent liquidity at a 2x current ratio and thus has the capital necessary to expand scale through acquisitions. This will help increase gross margins by spreading fixed costs and encouraging more clients, which will, in turn, reduce multiples yet further.

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Current analyst ratings for SLB. Source: FINVIZ.com.

As can be seen above, again, no analyst sees the company as overvalued right now. The median of price targets is around $110, and the range is $75 - $119. For a stock that offers a 1.7% dividend yield and an impressive brand name, the current price is a bargain and more than merits a "strong buy" recommendation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.