As energy explorers continue to spurn high-cost endeavors in response to last year’s coronavirus-induced shock, the Zacks Oil and Gas – Drilling industry is not out of the woods just yet as far as rig contracting is concerned. But the space is witnessing early signs of revival, as evidenced by increasing project sanctions. This should aid drilling contractors like Helmerich & Payne (HP – Free Report) , Transocean (RIG – Free Report) , Patterson-UTI Energy (PTEN – Free Report) and Nabors Industries (NBR – Free Report) .
The Zacks Oil and Gas – Drilling industry consists of companies that provide rigs (or specialized vehicles) on a contractual basis to explore and develop oil and gas. These operators offer drilling rigs (both land-based/onshore and offshore), equipment, services and manpower to exploration and production companies worldwide. Drilling for hydrocarbons is a costly and technically difficult enterprise, whose future is primarily dependent on the contracting activity and the total number of available rigs at a given point of time, rather than the price of oil or gas. Within the industry, it’s interesting to note that the volatility associated with offshore drilling companies is much higher than their onshore counterparts and their share prices are more correlated to the price of oil. Overall, the drilling stocks are among the most volatile in the entire equity market.
3 Trends Defining the Oil and Gas – Drilling Industry’s Future
Negative Impact of Cut in E&P Capital Programs: Last year’s slump in oil prices and the coronavirus-induced demand shock pushed drilling activity lower by introducing tremendous uncertainty around the exploration and production (E&P) spending outlook. From supermajors ExxonMobil (XOM – Free Report) and Chevron (CVX – Free Report) to smaller players like Ovintiv (OVV – Free Report) , all have made drastic cuts to their capital expenditures in an attempt to preserve cash and stay afloat. Obviously, this translates into lesser work for the companies that make it possible for upstream players to drill for oil and gas. While oil prices have rebounded strongly from the coronavirus-induced depths, most producers will likely continue with their cost-reduction efforts in 2021. With not much chance of a significant E&P capex cut reversal this year, drilling activity is expected to remain under pressure over the near-to-medium term.
Depleting Reserves to Fuel Drilling Demand: Amid the plethora of negative headlines, one of the key positive arguments for drillers is the focus on reserve replacement rate. Over the past few years, the supermajors have struggled to replace all of the oil and gas they churn out, raising concerns about future production. In this context, Chevron’s 2020 reserve replacement ratio of just 74% indicates the inability to add proved reserves to the amount of oil and gas produced. This clearly calls for a calibrated approach in meeting reserve shortfalls in the long run. Consequently, a gradual improvement in drilling activity looks likely.
High-Margin Contracts Replaced by Near-Breakeven Contracts: For most operators, order levels have remained depressed and day rates are trending just above cash costs. This has put increasing pressure on their revenue-generating capacity. Further, as the companies’ legacy, high-margin contracts wind down slowly, the drillers are faced with the prospect of a drop in backlog (and consequently, revenues), which is likely to accelerate over the next few quarters. This also leaves the drillers vulnerable to address their massive debt maturities and investment in newbuilds.
Zacks Industry Rank Indicates Bearish Outlook
The Zacks Oil and Gas – Drilling industry is a 7-stock group within the broader Zacks Oil – Energy sector. It currently carries a Zacks Industry Rank #188, which places it in the bottom 26% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates challenging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Despite the dim near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.
Industry Outperforms Sector & S&P 500
The Zacks Oil and Gas – Drilling industry has fared better than the broader Zacks Oil – Energy Sector as well as the Zacks S&P 500 composite over the past year.
The industry has surged 197.5% over this period compared with the broader sector’s increase of 37.7%. Meanwhile, the S&P 500 has gained 38.2%
One-Year Price Performance
Industry’s Current Valuation
Since oil and gas drilling companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of non-cash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), the industry is currently trading at 19.96X, higher than the S&P 500’s 16.25X. It is also well above the sector’s trailing-12-month EV/EBITDA of 4.93X.
Over the past five years, the industry has traded as high as 24.76X, as low as 5.92X, with a median of 10.86X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
4 Oil and Gas – Drilling Stocks to Keep an Eye On
Nabors Industries: Nabors is one of the largest land-drilling contractors in the world, conducting oil, gas and geothermal land-drilling operations. The company is well positioned with a sound mix of high-performance rigs and new rigs working in the key shale plays like Bakken and Permian. Despite the coronavirus Delta variant-induced uncertainties, Nabors anticipates a significant improvement in the oilfield segment fundamentals during the second half of 2021. The firm expects to make higher progress on the basis of its financial targets set for this year, courtesy of its exceptional staff, unrivaled global fleet capabilities and an expanding technology portfolio.
The 2021 Zacks Consensus Estimate for this Hamilton, Bermuda-based company indicates 26.48% earnings per share growth over 2020. Nabors currently carries a Zacks Rank #3 (Hold). The stock has gained 43.1% so far this year.
Price and Consensus: NBR
Helmerich & Payne: Helmerich & Payne is engaged in the contract drilling of oil and gas wells in the United States & internationally. Its technologically advanced FlexRigs are much in demand. The company has already upgraded most of its drilling fleet with the latest technology. Besides, Helmerich & Payne boasts a strong balance sheet, carrying around $481 million in long-term debt against $558 million in cash. In fact, the company’s debt-to-capitalization stands at just 13.8% compared with many of its peers that are hugely burdened with debts, accounting for around 50% of their total capital structure. With $750 million available under the revolving credit facility and a lack of significant near-term maturities, Helmerich & Payne should sail through any difficult operating environment.
The fiscal 2021 Zacks Consensus Estimate for this Tulsa, OK-based company indicates 44.37% earnings per share growth over fiscal 2020. The provider of land and offshore rigs carries a Zacks Rank of 3 and its shares are up 15.9% year to date.
Price and Consensus: HP
Patterson-UTI Energy: Patterson-UTI Energy is one of the largest North American land drilling contractors, having a large, high-quality fleet of drilling rigs. The company’s technologically advanced Apex rigs are the key to its success. Patterson-UTI’s proprietary design makes the rigs move faster than the conventional rigs, and drill quicker and more efficiently. Patterson-UTI’s impending acquisition of Pioneer Energy Services Corp. for $295 million is expected to boost its scale and geographic presence. Should the transaction go through, Patterson-UTI will possess 166 super-spec rigs in the United States with nearly 50% being outfitted with alternative power sources to minimize emissions. In addition, this takeover would expand Patterson-UTI’s geographic reach into foreign markets with the addition of eight rigs in Colombia where Pioneer has served for the past 14 years with a well-recognized operations staff and set-up.
The 2021 Zacks Consensus Estimate for this Houston, TX-based company indicates 9.22% earnings per share growth over 2020. The #3 Ranked stock has gained 47.7% in 2021.
Price and Consensus: PTEN
Transocean: Being the largest provider of offshore contract drilling services, Transocean’s unrivalled backlog of $7.3 billion offers cash flow visibility. As it is, the company’s technologically advanced and versatile drilling fleet differentiates it from competitors and provides it with an edge. Transocean reported revenue efficiency of an impressive 98% in the second quarter of 2021. This is an indication of minimal loss of revenues due to downtime and Transocean’s superior efficiency in translating its industry-leading backlog into cash. The company has also been taking necessary steps to enhance its fleet with modern and competitive rigs, while scrapping off old and incompetent drill ships, which is expected to make its operations more technically effective and efficient.
The 2021 Zacks Consensus Estimate for this Switzerland-based rig supplier indicates 13.16% earnings per share growth over 2020. The rig supplier carries a Zacks Rank #3 and its shares have gained 60.6% year to date.