“Drilling Down, Part Two”

By Travis Johnson, Stock Gumshoe, August 28, 2007

OK, so last time we were together I was talking about Elliott Gue’s four bargain oil drilling stocks, teased in an email late last week. If you’re just catching up with us now, that post is available here.

For the rest of you, let’s move right along and look at the other two companies teased in the email as the best bargain stocks in the oil drilling sector. I don’t think I own either of these, so hopefully I won’t be as long-winded as I was with Seadrill last time around.

Bargain Driller # 3:

“The growth market for this company remains the Eastern Hemisphere markets such as Africa, the Middle East and Asia. The company’s Eastern Hemisphere business posted year-over-year revenue growth of 40 percent, and management reiterated expectations that the level of growth would continue through the end of 2007.”

Well, that sounds pretty good. Gue says they’re growing better than their competitors in these “emerging markets” for oil drilling, and that they are pushing/relying on “directional drilling” internationally.

And apparently (this is all news to me, so I’m showing my ignorance here), directional drilling gis the order of the day — vertical drilling is tapping out in lots of older sites, I guess, and the more expensive and demanding directional stuff is moving in to keep production up.

Gue also quotes the company CEO as saying that they are counting on “solid expandables”, which are some kind of drilling technology, which again I don’t understand, that helps with deeper well drilling by expanding to fill holes that are drilled wider than required due to varying material types? I had to end that with a question mark because that’s just my understanding from the ad, I haven’t looked into that part in any more detail.

Then, finally, we get to a clue that I do understand:

“In my Wildcatter’s Portfolio, this stock is up 12% in the last four months.”

Ah, some real numbers! Hallelujah!

Well, this one pretty well has to be …

drum roll please …

Weatherford International (WFT)

This is another decent size firm — much bigger than Nabors or Seadrill. No crazy microcaps on this list, I guess.

It is up about 12% in roughly the last four months — I don’t know the exact date that he recommended it, but it was in the high 40s at the end of April and here at the end of August it’s at about $56, so that fits.

And Weatherford is into directional drilling, and solid expandables, and considers it and international expansion outside of their North American base to be a real growth driver for them. In fact, Elliott Gue himself wrote up an article touting these guys just a few weeks ago, using much the same language as in the teaser, for the Money Show folks.

Personally, I know next to nothing about this company — but I do see some value in the idea of investing in drillers with this more capable, complex technology. It is fairly cheap looking on paper, as all of these companies are, but it’s not as cheap as Nabors, for one — the trailing PE of 20 looks downright expensive for this group, but the forward PE of 13, if you believe the analysts, seems fairly reasonable. Sales growth has been plenty decent for a valuation like that, so I’m not sure I know why you’d pick WFT over similar firms, but certainly I’m getting the idea here that oil drillers do pretty well all still all look cheap at the moment.

Weatherford bought a big piece of service business from Precision Drilling a year or two ago, which has not worked out all that well in the last few months as the Canadian natural gas market has been pretty down in the dumps, but perhaps that will turn. Precision Drilling Trust (PDS), which I used to own shares in before I got scared off by the Canadian tax changes for trusts, is still a major owner of Weatherford with 26 million shares, so I suppose if they decided to make a change that could be a drag on the stock for a bit. T. Boone Pickens, the oil guru, bought shares in this one through the Spring and early Summer, even as he was selling some other energy companies, for whatever that’s worth, though I reckon he largely paid prices a bit lower than you can get today.

Whether or not WFT is really worth your money — well, you can trust Elliott Gue or you can decide for yourself. I recommend the latter.

Bargain Driller # Four:

This company “has owned and operated five generations of rigs since the ’70s, with a sixth generation under construction.”

“The company owns 42 semis and 13 drillships; more than its closest competitor. Moreover, their rigs are by far the most advanced.”

The company is fairly conservative, with contracts on most of its newbuilds before it even orders them.

They have “more than $21 billion in backlogged day-rate revenues over the next eight years.”

“Most of its high-spec rigs are booked solid through 2008 with only very limited capacity in 2009.”

A couple recent contracts:

“A third generation rig in the North Sea earning a day rate near $400,000, up from less than $150,000 per day on the current contract.

“A North Sea third generation rig contract … at $350,000 per day, roughly 75 percent higher than the same rig is currently earning.”

And the final clue: “The company just inked a deal to expand it fleet of rigs dramatically while handing shareholders a gigantic special dividend.”

So … did you guess this one? That special dividend helps to give it away, in case you want to sleuth around on your own for a bit …

No?

OK, this one is the granddaddy of all the deepwater drillers …

Transocean (RIG)

And as I noted when talking about Seadrill, they have significantly changed the deepwater landscape with their merger agreement with GlobalSantaFe (it’s kind of an odd merger — they’re swapping stock to create a new company, with no premium for either company’s shareholders, but they are also spinning off a big special dividend in cash to sweeten the deal). I don’t know what the timing is for consummating this deal, but it will certainly make for by far the largest deepwater drilling firm in the world … after all, Transocean was the largest, by a fair margin, even before this merger.

And they do have a very advanced fleet — I haven’t heard folks talk about “sixth generation” rigs before, they’re commonly thought to be churning out top of the line fifth generation rigs right now and in the near future, but I guess you could consider the drillship Discover Enterprise to be the herald of the sixth generation — looks pretty impressive to me.

As with all of these picks (what, am I getting soft?) I can’t come up with a particular argument against Transocean. Though I hold Seadrill personally, which is probably the most competitive with RIG in terms of high-capability deepwater stuff, especially over the next couple years, I do recognize that RIG is certainly the safer choice, the larger choice, and the market leader. And if they can get this merger off on the right foot they’re going to have some serious leverage with their clients thanks to their massive fleet, and even those third and fourth generation rigs that seem to me to be the bulk of their fleet are, as Gue notes, still getting some pretty nice dayrates.

So … there we go, four oil drillers that Gue says are bargains. I need to take get a bit grouchier, apparently, because these all seem perfectly reasonable to me. I don’t know much about Weatherford International, but I have been around the block a little bit with Nabors, Transocean and Seadrill, and I wouldn’t cry if anyone told me I had to put money into any one of them. If you do believe that oil drilling is going to be a moneymaking business over the coming decade, I expect all of these folks ought to do well … but of course, given the valuations on these shares right now, there are clearly lots of folks who DON’T believe that. The market has been great, but the real danger appears to me to be the supply-demand balance — are the rigs that everyone’s climbing over themselves to pull out of mothballs and order from the big shipyards going to be competing with each other and driving prices down, or is demand so high and growing so fast that the increased supply won’t matter.

Hmm, yeah, I don’t know, either. Good luck figuring that one out, and I’m happy to see Gue recommending some stocks that I can understand that have real earnings — these sound a lot better to me than Novozymes or Unor did.

Happy investing, everyone.

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