These Sub-$8 Oil Stocks Could Be Takeover Targets

Includes: KEG, MDR, TA
by: Hawkinvest

I recently wrote about companies in the oil sector which appear cheap and could also be potential takeover targets. As suggested in a recent article, smaller companies in this sector such as TravelCenters of America (NYSEMKT:TA) could be an ideal takeover target for a major oil company, and it also seems to have upside due to a dirt-cheap valuation. After doing additional research, there appear to be a number of other oil stocks that could also be takeover targets.

With oil prices showing strength, and since the U.S. economy is seeing some growth thanks to the auto and housing sector, the conditions could be ripe for additional merger and acquisition deals in the oil industry. Here are a couple of other oil stocks that appear to have longer-term upside as well as takeover potential:

Key Energy Services, Inc. (NYSE:KEG) shares peaked out at around $9.50 in February and have been bouncing around what appears to be the bottom at about $6 per share. At these levels, the stock appears undervalued for any investor with a mid to long-term outlook. Key Energy is a leading provider of rig services, rental equipment, drilling fluids, tubing, fishing services, well testing, hydraulic choke services and more.

This stock took a beating when the company announced disappointing results for first quarter of this year and more recently, a 1 cent per share profit for the second quarter of 2013. However, after the stock dropped earlier this year, the CEO and other insiders took advantage of the sell-off. For example, on May 2, 2013 Newton Wilson (an officer) bought 10,000 shares at $6.34, in a transaction valued at $63,400. On May 1, William Fertig, (a director) purchased 20,000 shares for $5.97, in a transaction valued at $119,400. On the same day, William Owens, (a director) bought 10,000 shares at $5.83 in a transaction worth $58,300. On April 29, Richard Alario (the CEO), bought 50,000 shares at prices between $5.92 to $5.99 in a transaction valued at $298,000. On the same day, Ralph Michael (a director), bought 10,000 shares for $5.95, in a transaction valued at $59,500.

This totals insider buys of about $600,000 in just a few days after a major sell-off. That is significant because it was a number of insiders buying, and because it appeared to be buying based on the drop in the share price. It is also significant because some of these insiders already have significant amounts of stock. For example, the CEO, Richard Alario owns about 1.3 million shares. It's a real positive when management owns and buys more stock since that means their interests are aligned with shareholders. Some funds are buying big too, MHR Fund Management (on May 28, 2013), reported taking a stake that is equivalent to 11.5% of the entire company.

The stock looks significantly undervalued when considering book value and the forward PE ratio. Book value is currently about $8.22 per share. Analysts expect the company to earn a small profit in 2013, but expect profits to jump to 45 cents per share in 2014 and to 76 cents per share for 2015. If the company achieves these results, the stock price could easily be valued at $10 to $12 per share, or more than double the current price. Those estimates even seem conservative since the company earned $1.27 in 2007 and $1.28 in 2006. Back then the stock was trading for about $18 per share and more recently (in 2011), it was even over $20. This shows the type of gains that investors might see when business conditions are ideal.

Another positive factor to consider is that in the past, Key Energy has been considered to be a takeover target. The Houston Business
Journal wrote:

Houston-based Baker Hughes Inc. (BHI) is looking to make deals as it tries to extract bigger profits from the U.S. shale boom, Bloomberg reports. Houston-based Key Energy Services Inc. and Lufkin Industries Inc. might be on the services company's wish list, according to Bloomberg.

Not too long ago Lufkin was acquired by General Electric (NYSE:GE) and if another oil services company wanted to buy Key Energy, now would be the time as the valuation is low and the growth prospects remain
strong going forward. Oil industry fundamentals and growth prospects look strong as demand for energy is expected to rise in the future. Because of this, merger and acquisition prospects look good as the economy recovers from a tough few years. Companies like Baker Hughes, Schlumberger (NYSE:SLB), Halliburton (NYSE:HAL) and General Electric could all find an oil services firm like Key Energy as an attractive target to acquire.

Here are some key points for KEG:

  • Current share price: $7.05
  • The 52 week range is $5.61 to $9.57
  • Earnings estimates for 2013: 10 cents per share
  • Earnings estimates for 2014: 45 cents per share
  • Annual dividend: none

McDermott International (NYSE:MDR) shares recently plunged after it announced financial results. This company is based in Houston, Texas and it provides engineering and construction services to the oil and gas industry. While this company appears to have some significant issues in terms of operations and management execution that have led to recent losses, this stock could be interesting as a long-term turnaround play.

For the second quarter of 2013, McDermott posted a loss of $149.4 million, or 63 cents a share, on revenues of $647.25 million. This is significantly worse than analyst expectations for earnings of 3 cents per share and revenues of $757.7 million. These results also were disappointing when compared to earnings of $52.7 million for this same quarter last year. It seems the company is facing competitive pressures and it looks like it underestimated the expenses on certain projects. A Barron's article details some of the reaction by analysts to McDermott's woes and it states:

Today, McDermott was downgraded from Buy to Hold at D.A. Davidson, while Stifel Nicolaus also cut its rating from Buy to Hold. Analyst Robert Connors cited a "lack of execution credibility and feasible near-term prospects ... MDR's execution mishaps within the past few years have been the result of underinvestment, increased competition, leading to a lack of management oversight and adherence to risk control practices."

It appears the weakness in operating results could persist into the next couple of quarters and maybe beyond, so the stock might stay cheap or get cheaper in the coming months. However, it could be worth accumulating on dips for a longer term turnaround play and some analysts believe the company could be a buyout target. A recent Bloomberg article details why McDermott could be a takeover target and some of the companies that might be interested; it states:

After its decline, competitors Saipem SpA (SPM) and Technip SA (TEC) could pursue McDermott to gain its fleet of offshore vessels for installing heavy pipelines, according to Capital One Financial Corp. (NYSE:COF) McDermott may even attract more traditional engineering and construction companies such as KBR Inc. (NYSE:KBR) and Foster Wheeler AG (FWLT), Stephens Inc. said.

"The McDermott name is well-recognized globally," Michael Marino, an analyst at Stephens Inc. in Houston, said in a phone interview. "There's some value in that, which someone might find attractive."

Clearly there are downside risks since this company is posting losses. However, this company has a solid balance sheet with about $427.7 million in cash and around $95.64 million in debt. But, with losses of nearly $150 million in a single quarter that cash could be eaten up rather quickly if this company does not quickly manage expenses. I believe it is too early to get into this stock and I doubt another company would want to take the risks of buying it until there is more clarity in its financial results. There is also new litigation pending against McDermott which alleges that the company violated the Securities Exchange Act of 1934 between November 6, 2012 and August 5, 2013. This litigation, along with operational issues that may persist before possibly improving, could keep this stock under pressure. We are also just a few weeks away from the 4th quarter which is when tax-loss selling typically begins and that could put more pressure on this stock. Therefore, I would suggest watching this stock for now and considering it as a potential buy later this year for the longer-term potential it may hold.

Here are some key points for MDR:

  • Current share price: $7.64
  • The 52 week range is $6.68 to $13.56
  • Earnings estimates for 2013: a loss of 40 cents per share
  • Earnings estimates for 2014: a profit of 54 cents per share
  • Annual dividend: none

While all of the stocks mentioned here appear to have upside and takeover potential, I believe that TravelCenters is the best value at this time. All of these stocks trade for just over $7 per share, however, McDermott is posting losses and Key Energy Services is barely profitable. By contrast, TravelCenters just posted a profit of 54 cents per share for the second quarter of 2013. Because TravelCenters is earning so much more than these other companies, it appears to have reduced risks and it also has plenty of upside and takeover potential. However, Key Energy Services and McDermott could be turnaround and takeover plays to consider for the long term.

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: I am long TA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.