“Two Stocks You Must Buy Before Gas Blows Past $4 Per Gallon…”

By Travis Johnson, Stock Gumshoe, March 8, 2011

The Motley Fool copywriters seem to love this general type of pitch — “Must buy X before Y happens!” — they used it heavily for their multiple teases of American Tower, among others (buy before the iPhone 4, then buy before Verizon gets the iPhone … I assume we’ll also see it again when the speculation about iPhone 5 heats up).

So now that oil prices are rising, we get the “must buy before gas blows past $4” stocks — and several intrepid Gumshoe readers are asking for answers … so let’s dig in, shall we?

The tease is for the “flagship” newsletter over in Fooldom, the Motley Fool Stock Advisor from Dave and Tom Gardner, and it’s all about oil services companies.

Actually, that’s not true, it’s mostly about oil prices and Saudi Arabia — the speculation that if the unrest that has moved through Algeria and Egypt to Libya, Yemen and elsewhere really takes hold in Saudi Arabia and starts to threaten production from the only OPEC country that most people think can really crank open the taps if needed (though there’s some debate about their spare capacity and reserves in the Kingdom, too, with lots of folks thinking — even before the WikiLeaks revelations — that their reserves are significantly overstated).

So the trend behind this ad, and these stock ideas, is that oil and gas are going to go up in price, and that the climb in prices might be even more dramatic than the recent spike to over $100 a barrel. And this is certainly an attention-getting idea among both drivers and investors these days, since even though our economy is far more efficient with oil now than it was twenty or thirty years ago, and even though domestic production is actually rising for the first time since the late 1980s … we are still a nation that depends heavily on imported oil — and gas prices seem to continue to have an outsize impact on consumer sentiment.

Many of us have already seen $4 gas prices, depending on where you live and how opportunistic your local retailers are, but the average national price is closing in on that number pretty quickly — it’s over $3.50 now and rising, so the idea that it will surpass the old record of $4.11 or so (set when oil was nearing $1.50 in the Summer of 2008) is certainly not an “out there” prediction. Of course, if the expected “day of rage” in Saudi Arabia on Friday actually turns into a circle of smiling people singing Kumbaya (or the arabic equivalent), one can probably assume that the price will lose a lot of this recent steam at least in the short term — despite the fact that a growing (if it continues) global economy, with more drivers in China and elsewhere, will continue to gradually increase demand.

But you’ve probably heard most of that, so I’ll spare you the long spiel from the Fool about what might cause oil prices to rise even further — let’s get straight to the companies they tease as hot investments in this rising price environment …

“You see, only a handful of highly specialized companies — like the two I’m going to introduce you to today — have the state-of-the-art technology, the specialized skills, and the artful know-how needed to tap the world’s next great oil fields.

“That’s because these fields are located in some of the hardest-to-reach places on Earth — hundreds of miles offshore and thousands of feet below the ocean’s surface.

“In other words, these two little-known companies are absolutely essential to the success of any big name oil company that wants to extract oil from these vast, ultra-profitable deposits.”

So it sounds like we’re about to get some hints about offshore drillers, eh? Well, that’s at least one of the stocks — let’s get the details.

First we’re told that one advantage they have over the oil majors is that they’re smaller, so therefore perhaps easier for them to see significant growth …

“the relatively small size of these two highly specialized companies is actually a huge advantage.

“Especially considering they’re both growing like wild fire… are trusted leaders in their respective fields… and have highly experienced, shareholder-friendly management teams.”

Then we get a few specifics for the first company teased:

“… the first company I’m going to tell you about today is in such high demand right now….

“Charging big-name oil companies like Noble as much as $545,000 per day to drill wells in 5,000 feet of water off the coast of remote African nations like Ghana and Equatorial Guinea…

“While also drilling in more easily-accessible places like the waters off Australia and Malaysia for clients like Chevron and Shell (jobs which each bring in more than $400,000 per day)…

“And rapidly expanding its fleet — including adding three more ultra-deepwater rigs (one of which will come online within months and is already under contract) — giving it a major leg up on its competitor’s aging and outdated fleets….

“… its PE ratio currently sits at less than half that of its more well-known competitors like Transocean (meaning you can buy it much cheaper).

“Combine that with the fact that this company is sitting on over $200 million in cash (which will allow it to continue to expand its fleet)… has an extremely healthy balance sheet… and has grown profits at an average compound rate of 50% per year over the past five years…”

So we toss all those goodies into the Thinkolator and find that … yep, this is a stock that Dave Gardner recommended not only last year, but also the year before, Atwood Oceanics (ATW), probably the smallest of the publicly-traded, deepwater-focused oil drillers.

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Atwood is a tempting target now, as it was back in 2009 when David Gardner was teasing it for this same newsletter — with, now that my memory has been rekindled, almost the same pitch (“buy before gas prices soar“).

In the spectrum of deepwater drillers the tendency has been, for whatever reason, for the US companies to be relatively conservative, keep a reign on debt, and refurbish rigs rather than build hugely expensive new ones, while the Norwegians have been the aggressors in using heavy leverage and aggressively filling up the order books of the few global shipyards who can build the most capable fifth and sixth generation deepwater rigs and drillships. When looking at larger drillers, the difference is most easily understood by comparing Diamond Offshore to Seadrill — both have great businesses and spin off much of their cash flow to investors in the form of high dividends, but DO has an older fleet of rigs and doesn’t have much debt or revenue growth, and SDRL has the most modern big-company fleet and is highly levered and is growing quickly thanks to new rigs and turnover.

Both models, and any mix inbetween, can probably be quite successful during a time like this, when the demand is very high for all kinds of floating rigs — not just the absolutely most capable ones that can drill in water two miles deep, but even those that can drill in a few thousand feet of water. Atwood is a very small company in terms of fleet size, they have three ultra-deepwa