Precision posted results for the fourth quarter of 2010 that were better than analyst expectations. Given they report before other Canadian service names such as Trican (OTCPK:TOLWF), Calfrac (OTCPK:CFWFF), Savanna (OTC:SVGYF), Trinidad (OTCPK:TDGCF) and Ensign (OTCPK:ESVIF), they are often a bellweather for the sector. In addition, management’s outlook was strong for Q1 which is typically the strongest quarter of the year. I expect the other names in the group mentioned above will put up strong numbers and should be bought ahead of their releases. Precision had a few one-time items that had a negative impact on the quarter and hence the stock was roughly unchanged after the Q4 results were reported. The other names mentioned above are not likely to have similar one-time items.
The medium term looks much improved for energy service activity in Canada and the United States. 60% of Precision’s rigs are currently drilling for oil and this commodity is now the driver for North American activity. This demand is linked to the much more stable price of oil, rather than depressed natural gas prices. If natural gas prices actual improved, the market could become very tight for service equipment, however we are likely still a year or two away from seeing natural gas production contracting enough to improve prices.
Clearly the market has had a great run over the past few months and the services sector is typically a higher beta area than the producers or refiners, so a general market pullback would hurt the group. Nevertheless, many of the drillers are still trading below longer term P/B multiples and I like Savanna as it carries the lowest such multiple in the group. The fracturing companies Trican and Calfrac have outperformed the drillers over the past year, but now their stocks are back close to long term average P/B multiples. The pending IPO of Frac Tech may also draw some investment dollars away from those existing fracturing companies, so I have put my own dollars behind the drillers at this point.
As a potential exit point, we think the lead up to those strong Q1 earnings to be released in late March or early April might be a good time. While we see oil and gas prices holding steady at present levels, Q2 results in Canada are seasonally weak and there is less to look forward to in the summer months. We are close to two years into the recovery in the sector and often the up cycle can last 3-5 years, so there are reasons to remain in the space. I expect the smaller capitalization names will have more upside than the bigger names as we head towards the latter part of the cycle.
Disclosure: I am long OTC:SVGYF.