There's Still Room For Parker Drilling To Outperform

| About: Parker Drilling (PKD)
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Parker Drilling (NYSE:PKD) has been a public company for quite some time, but the company hasn't had what you'd call a consistent record of performance. Energy services, and drilling particular, has always been a volatile, cyclical business, but I would estimate that the company has only earned its cost of capital once or twice over the last decade. Maybe it's not altogether surprising then that the stock has stayed pretty much stuck in a band between $4 and $6 over the past four years.

These shares dipped slightly below that range in April of this year, only to exceed it slightly in July and here again more recently, but I believe these shares may yet be undervalued. Demand for drilling barges in the Gulf of Mexico has picked up, and so too has demand for rental tools (particularly for deepwater activities). At the same time, I think the company's progress with its international operations still has not been fully appreciated by the Street. Although Parker Drilling remains a "show me" story, I wouldn't be surprised if these shares trade between $8 and $9 before too much longer.

A Tale Of Two Businesses; First The Contract Drilling...

Roughly two-thirds of Parker's revenue comes from contract drilling operations across three segments - U.S. barges, U.S. drilling, and international.

Parker owns 13 drilling barges in the U.S., with operations focused principally on the Gulf of Mexico. Although barges are rather limited in where they can operate (it's relatively rare to find drilling barges that can work in water depths of more than 150 feet or so), they are smaller, more mobile, and relatively economical drilling options for particular applications. Barge utilization rates have been strong recently in the Gulf, leading to solid day rates, and Parker is in the process of bringing its 12th barge back into service. Competition is relatively limited; Parker is around half of the Gulf barge fleet, with Nabors (NYSE:NBR) and Trinidad Drilling (OTCPK:TDGCF) as two of the larger/better-known competitors.

Parker also has a small (two-rig) U.S. land drilling operation, with both of the rigs working under a long-term contract with BP (NYSE:BP). These rigs are deployed in Alaska and designed to work in the harsh operating conditions of that area.

Last and by no means least is Parker's international land rig business. This segment generates the majority of Parker's drilling revenue and consists of 24 land rigs and two offshore barges. Of the 22 available rigs, nine operate in Latin America (Mexico and Colombia) and 13 operate in the Eastern Hemisphere (5 of which are in Kazakhstan).

This has been a challenging business for Parker, as operating a few rigs "here, there, and everywhere" has led to unimpressive returns for the company. One of the major objectives of the relatively new management team is to improve results here; in part, by improving the geographical footprint and concentrating on better utilization. Utilization rates were in the low 40%s as recently as the fourth quarter of 2012, but have been improving pretty steadily - up to 53% in Q2'2013 and 68% as of the month of August.

Rental Tools Set To Benefit From More Activity And Better Management

The other third of Parker's revenue (but about half of gross profits) comes from its rental tools business. The company's Quail Tools business is a domestic renter of premium tools, including drill pipe, tubing, drill collars, and blowout preventers. Although Parker is quite a bit smaller than Weatherford (NYSE:WFT) or Schlumberger (NYSE:SLB) in the global rental business, Parker does often manage to secure a small premium with its pricing due to its higher reliability (which in turn is due to a rigorous inspection and maintenance program). Quail Tools is benefiting from improving deepwater activity, though the overall level of activity in North America hasn't been the greatest this year.

On the other side, Parker also has its ITS international tool rental business. Parker acquired this business earlier this year out of bankruptcy, so you can imagine that it's not exactly the picture of health - as ITS's problems worsened, suppliers pulled back on the credit they'd offer, making it harder for the business to operate. Although I don't think ITS is going to be a major contributor right away, I do think adding an international tool rental business makes sense as a way to leverage, and maybe eventually augment, the company's existing international drilling business.

Will A New Approach Lead To Better Results?

As I said before, the management team at Parker Drilling is relatively new. Gary Rich joined as CEO (from Baker Hughes (BHI)) in October of 2012 and CFO Chris Weber (formerly of Ensco (NYSE:ESV) joined earlier this year. With a new management team in place, there is also a new, better-focused strategy for the company. From the sounds of it, Parker will be focusing a great deal more of its efforts on growth markets like the Gulf of Mexico (both with barge drilling and tool rental), as well as restructuring the international drilling operations to maximize utilization and returns.

I'm cautiously optimistic that this refined approach can lead to better results. With day rates already in the mid-$30,000s, I believe the barge drilling business can still benefit from improving activity in shallow water Gulf drilling. Likewise, while Parker may not have quite the same scale in rental tools as Weatherford or Schlumberger, I don't think Parker needs to be all things to all customers - focusing on rental tools leveraged to growth in offshore/deepwater activity can be a solid niche growth strategy. Given the comments and activities of Schlumberger regarding offshore/deepwater exploration and production, I do believe this can be a multi-year growth opportunity for Parker.

Last and not least, I think the company has turned the corner with its international operations. ITS is going to be a multi-year project, but the improving utilization rates for the international rig fleet is encouraging.

The Bottom Line

Given Parker's relatively poor (or at least very uneven) historical performance, it probably shouldn't be a surprise that its historical forward EBITDA multiples haven't been all that good. With new management in place and improving results evident so far this year, I argue that a higher multiple is appropriate. With that, I'm using a 4.5x multiple to the current average 2014 sell-side EBITDA estimate, or about $8 in fair value. Should Parker continue to prove itself, I believe the EBITDA estimates and multiple can head higher, and other analysts may add coverage (only three sell-side analysts cover Parker).

I'm already overweight to energy stocks today, and I'm also fond of Basic Energy Services (NYSE:BAS), but I do believe Parker still has worthwhile upside and is worth a look from more aggressive investors willing to take on the risk of a turnaround story still in progress.

Disclosure: I am long WFT. 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.