Time to Pull the Trigger on Four Oil Service Stocks

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Includes: BHGE, RIG, SLB, WFT
by: Larry Bellehumeur

As a Value Investor, I routinely find myself stepping in front of "Moving Trains" to buy beaten up stocks. Sometimes when you do this, you get run over and end up catching a "Falling Knife". Other times, you find yourself at the beginning of a "Hockey Stick curve climb" (sorry, Canadians have to refer to Hockey once in a while!).

With the incredible fall of the price of oil recently, many oil services stocks have been dragged down considerably. Some of the observed drop in these stocks might not be fully warranted, though. Although their clients (namely the Large Oil Companies and Nationalized Oil Programs) may receive less money for their barrel of oil today than earlier in 2008, the fact that oil prices are still over $100/barrel means that there shouldn't be any significant impact on the search for new oil production. As well, many of the oil services companies have signed long-term contracts for set rates, so earnings are unlikely to be affected significantly by Day-to-Day Commodity price swings. In my opinion, oil would have to fall below the $60 mark for there to be a significant downturn in the work for these companies.

Here are 4 companies that I like for the long-term investor:

1) Schlumberger (NYSE:SLB)

If you are going to only own one oil services company in your portfolio, you could do a lot worse than owning the largest of them all. With its incredible array of services, Schlumberger has its "tentacles" in all aspects, from the early stages of E&P (Seismic testing) to Drilling (huge array of Well Services) to Project Management and IT Services. As well, its incredible geographical spread means that the company doesn't receive more than 30% of its income from any one particular region, providing some protection in the event of political instability or an economic downturn.

Of course, this great company doesn't come cheap... the great ones never do. Schlumberger almost always trades at a significant premium to the S&P, but has consistently shown its ability to increase its earnings and cash flow at an excellent rate, justifying the premium.

With an estimated 2009 earnings of about $6.00, and an anticipated current year P/E of 20x, I suspect that Schlumberger will make its way (sometime in 2009) to new highs, touching the $120 level. This would be a 30% climb, which is a great return in this current market.

Again, not a cheap stock at this price, but one that has great long-term value.

2) Weatherford (NYSE:WFT)

Like Schlumberger, Weatherford also offers an incredible array of oil services to its valued customers. It also has some long-term contracts that help to stabilize its earnings, at least somewhat.

One way that Weatherford does differentiate itself a little bit from SLB is that fact that it gets a higher percentage of its revenue (about 50%) from North America. While this has been improving slightly in the past few years, it does leave the company a little more exposed to a potential downturn in the North American natural gas market than SLB. This extra leverage may not be a bad thing, however, as many analysts are predicting an upturn in natural gas drilling over the next few years in North America.

Also, unlike SLB, Weatherford does not pay a dividend, as they are still strongly looking for key acquisitions in this market. Weatherford does trade at about ½ of the price to book ratio of SLB, making it a better value, at least in my opinion.

With an estimated earnings just shy of $3 for 2009, and an estimated current year P/E of 18 (reflecting its lack of geographical diversity), Weatherford should see the mid-$50 range sometime in 2009. This would make it about a 50% upside from its close on Friday.

3) Baker Hughes (BHI)

Most high-school boys have (or had) a gal that always breaks your heart. This is kind of how I feel about Baker Hughes. Sure, it has been a good performer for me (a little over a double, in four years), but it always seems to find a way to disappoint here and there on the earnings front.

Despite that, I am still recommending BHI for the long-term investor. While its diversity and scope of services may not be as strong as SLB, Baker Hughes does have good exposure to all areas of the world (with only a 30% exposure to the US) and a good balance to its offerings to its customers.

It does appear to have a strong tie to the Western Canadian Sedimentary Basin, as evidenced by its miss in earnings last year during the temporary downturn in activity in the region. Nevertheless, BHI trades at a discount to SLB and WFT that (I believe) more than takes all of these factors into account.

With an estimated earnings of around $6.50 for 2009, and a P/E of 16 (which reflects the expected growth rate, according to analysts), Baker Hughes should pass its previous high and break into the $105 range sometime in 2009.

4) Transocean (NYSE:RIG)

I'll leave the stock that is the most undervalued for last! Critics will point out its greater vulnerability to the actual price of the commodities than other Oil Services companies (since it costs a staggering amount more to drill off-shore, these projects may be cut first in the event of a quick downturn in the price of oil). As well, I have observed on Bloomberg how a few analysts were concerned about both competition coming online in 2-3 years (pressuring their day rates) and how they are more exposed to natural disasters, such as hurricanes and tsunamis.

Having said all that…..this stock is dirt cheap. Few stocks could have had the meteoric rise that RIG did, and still be considered cheap (I have owned this stock since I bought it in the $40 range, sometime in early 2005). RIG's earnings growth rate has also been equally as spectacular.

Many of RIG's customers have committed to long-term rates, providing a modest amount of stability. Most rigs are booked up for the next several years, with PetroBras having locked up many of them for their recent off-shore discoveries. As well, day rates for their products have sky-rocketed (averaging almost $240K in Q2, 2008), with some rigs fetching much more than that.

Finally, I would have thought that this stock would have had more of a pop with one of the key election topics being how the US should focus more on off-shore drilling. As the largest Oof-shore driller in the world, this would likely be a boom for RIG. Barring an absolute collapse in the price of oil (perhaps back down to the $50 level?), RIG's services will be in huge demand for years…..

Based on a 2009 earnings estimate of $16.00 (I've lowered it a bit from consensus earnings, to be conservative), and a current year P/E ratio of 12, this stock might come close to hitting $200 some time in 2009. I believe that eventually, when the market believes that $100 really is the floor for oil prices, and there is further talk of US off-shore drilling, this stock even has room for some multiple expansion, making my targets seem very conservative.

Disclosure: Long RIG, BHI, WFT. In addition, BHI and SLB are customers of my company.

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