The Zacks Oil and Gas - Drilling industry consists of companies that provide rigs 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.
Let’s take a look at the industry’s three major themes:
- U.S. oil prices have rallied more than 30%, while the international benchmark is up around 26% since hitting multi-moth lows on Christmas Eve. Consequently, work for drillers – particularly onshore – has picked up again. Notably, international rig count has been rising in the past few months, which should lead to improvement in the operators’ revenues and profitability. Again, thanks to the emergence of major shale plays yielding impressive results over the last few years, there has been an overwhelming requirement for complex drilling in the United States. This has led to huge demand for new premium land rigs that command higher pricing. The steady-to-positive crude narrative coupled with the American shale drilling frenzy has helped prop up the growth prospects for the advanced and technically superior land rig suppliers.
- On the other hand, recovery in oil prices have not led to significant activity for offshore drillers. The three-year price slump has forced the top energy companies to cut spending (particularly on the costly drilling projects) due to lower profit margins. This, in turn, has meant less work for the beleaguered drillers as offshore exploration for new oil and gas projects are nowhere near the pace of improving oil prices. With old contracts rolling off, the companies are either getting rigs stacked or bear high reactivation costs and accept much-reduced dayrates. As a result, overall revenues are impacted. However, steadiness of oil prices at the current levels is driving operators to make longer-term plans, as deepwater projects become cost effective if taken up for a considerable time period. This could increase demand for offshore drilling rigs. Moreover, certain segments of the industry are experiencing higher dayrates that reflect an overall uptick in the sentiment.
- The highly cyclical nature of the industry makes its participants – who generally build big and expensive drilling rigs – heavily dependent on the prevailing business environment. In other words, it’s extremely difficult for any driller to perform well during a commodity downturn. However, the ability to come up with technologically superior products with higher efficiency can help companies gain a competitive edge in the market. Within the industry, it's interesting to note that 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. But investors should keep in mind that these stocks are prone to quick falls too, unlike the stocks of land drillers.
Zacks Industry Rank Indicates Improving Outlook
The Zacks Oil and Gas - Drilling is a 14-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #100, which places it in the top 39% 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 impressive 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.
Before we present a few stocks that you may want to consider, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Lags Sector & S&P 500
The Zacks Oil and Gas - Drilling industry has lagged the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.
The industry has declined 47.2% over this period compared to the S&P 500’s gain of 4.3% and broader sector’s decrease of 17%.
One-Year Price Performance
Industry’s Current Valuation
Since oil and gas 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 noncash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, the industry is currently trading at 8.14, lower than the S&P 500’s 11.22X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 4.88X.
Over the past five years, the industry has traded as high as 13.38X, as low as 4.22X, with a median of 7.89X.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio
With the energy sector emerging from the crude slump and debt-driven overhaul, renewed interest in the drilling space is finally raising hopes for the industry’s recovery. But even if commodity prices improve, structural oversupply and pricing pressure will weigh on the sector constituents’ operating margins.
However, sector consolidation, adoption of superior technologies, new operational systems’ optimization of the fleet by strategic sell-offs and acquisition, seeking profitable collaborations, among other strategic strides, will certainly help boost the prospects of the drilling companies. While one does not expect the sunny days of the drilling industry to return immediately, signs of recovery can definitely be seen. Increased adoption of sophisticated land rigs in the United States and an uptick in the international rig count will be the key catalysts.
None of the companies engaged in oil and gas drilling currently sport a Zacks Rank #1 (Strong Buy) or 2 (Buy). However, we are presenting a few stocks with a Zacks Rank #3 (Hold) that investors may currently hold on to.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Helmerich & Payne, Inc. (HP): This Tulsa, OK-based company is engaged in the contract drilling of oil and gas wells in the United States and internationally. Helmerich & Payne has an expected earnings growth of 1,035.7% for FY 2019.
Price and Consensus: HP
Precision Drilling Corporation (PDS): Based in Canada, Precision Drilling is primarily an onshore drilling and well-servicing contractor providing a complete range of services in North America and the international markets. The company has an expected earnings growth of 61.5% for 2019.
Price and Consensus: PDS
Nabors Industries Ltd. (NBR): This Hamilton, Bermuda-based company conducts oil, gas, and geothermal land drilling operations and is one of the largest land-drilling contractors in the world. Nabors Industries has an expected earnings growth of 27% for 2019.
Price and Consensus: NBR
Independence Contract Drilling, Inc. (ICD): Based in Houston, TX, the company provides onshore drilling services with its premium rig fleet. Independence Contract Drilling has an expected earnings growth of 105.9% for 2019.
Price and Consensus: ICD
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