Oil Service Companies Are Cheaper, May Be Safe Way to Invest in Oil

by: Michael Filloon

No matter the sector or company, it would be crazy to jump into stocks as the technical indicators begin to break down. But when fear is at its greatest, stocks are the cheapest. Commodities have been quite good to investors as the value of the dollar has dropped significantly since the bull run started. Oil has been a good way to play this. With the threat of a world wide slow down, the price of oil should decrease as demand wanes.

There is no certainty of this as Wednesday's oil report was bullish with a draw down in oil inventory. US crude inventories decreased 5.2 million barrels in the latest week. The IEA lowered its global oil demand outlook for 2011. Although the news for crude was bullish, forward outlook was bearish. Starting positions in oil production companies may not be the best idea, even with recently upgraded companies Brigham (BEXP) and Kodiak (NYSE:KOG).

It is my assumption the oil service sector may be a safer way to play the oil space. The price of oil will undoubtedly be volatile, and could very well slip into the low 70s in the short term on global slowing and a dollar strengthening against the euro. In my opinion RPC Inc. (NYSE:RES) is a good way to play this space. On Monday, RES announced it had hired Goldman Sacs (NYSE:GS) for advisory on selling its company.

I have been bullish on RES for some time, as one half of the company's business is derived from pressure pumping. In several of the major shale plays in the United States, there have been steep increases in costs related to pressure pumping. Pressure pumping is needed for fraccing and this is why cost per hydraulic horsepower has sequentially increased.

A good example is in the Williston Basin. Frac crews were already difficult to come by at the beginning of 2011, but a harsh winter and flooding pushed frac backlogs further. Prices of completion services have increased enough to push Oasis (NYSE:OAS) to create its own well services company. It estimates there will be a savings of $800,000 to $1,000,000 gross well. Oasis is investing $24 million to set up Oasis Well Services.

Basic Energy Services (NYSE:BAS) is my favorite in the space. It also derives a large portion of its revenues from pressure pumping. Acquisitions are allowing Basic to grow, while it increases revenue. Its second quarter revenue increases quarter over quarter are:

  • Completion and Remedial Services: 25% increase to $121.8 million.
  • Fluid Services: 13% increase to $81.4 million.
  • Well Servicing: 21% increase to $83.9 million.
  • Contract Drilling: 38% increase to $9.8 million.

Basic is well positioned for growth. It has a one year price target of $42.93 and a forward P/E of 7.8.

Complete Production Services (NYSE:CPX) beat second quarter estimates on the top and bottom line. Revenues from completion and production were $491.9 million, an increase of $54.8 million quarter over quarter. Its drilling services revenue increased by $2.1 million quarter over quarter to $52.2 million. Complete recently purchased a hydraulic snubbing and production testing business with operations in the Eagle Ford and Marcellus shale. It has a one year target of $48.68 and forward P/E of 7.07.

Key Energy Services (NYSE:KEG) saw revenue increase sequentially in the second quarter by 11.4%. International revenue increased 27.6% over the same time frame. It announced higher activity and pricing improvement in all lines of its business. Key Energy like Basic Energy recently made an acquisition to add to its completions business. In the second quarter Key Energy reported over half of its revenue is now from new well drilling and completion related work. It reiterated the guidance of increasing 2011 revenue by 50% to 55% over 2010. It has a one year target of $22.97 and a forward P/E of 8.73.

Oil States International (NYSE:OIS) had a very good second quarter. It saw revenue growth through all aspects of its business year over year:

  • Accommodations: 66% increase
  • Well Site Services: 36% increase
  • Rental Tools: 42% increase
  • Offshore Products: 24% increase

Drilling and tubular service both saw revenue and margin increases. Oil States International has a one year target of $99.82 and a forward P/E of 9.4.

To see the expansion of oil service work in the United States one could look at any of the player's utilization and pricing. Haliburton (NYSE:HAL) announced during its second quarter earnings that much of its revenue growth was derived from United State's land including all lines of product and service. North American revenue grew 16% sequentially with operating margins higher than 50%. Baker Hughes (NYSE:BHI) reported North American revenue growth of 37% year over year. Weatherford (NYSE:WFT) reported its United States second quarter revenue was strong and expansion of margins continued. Schlumberger (NYSE:SLB) stated the second quarter had United States sequential revenue growth of 21%, with sequential margins up 287 basis points. Schlumberger stated this was driven by demand for pressure pumping and drilling activity.

It is obvious that oil service companies are able to grow business in the United States. This growth was possible even with the first two quarters in the Williston Basin being slow due to poor weather. I think this entire sector will continue to improve its business in the United States as I think it could take several years to begin to understand the growth of unconventional resource throughout the world. The recent pullback in the market has created an opportunity to start positions in an industry with very good prospects. Look for names specifically levered to the United States.

Disclosure: I am long BAS, RES, BEXP, KOG

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