Are Oilfield Service Companies A Buy?

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Last week, we presented a bear case for the energy sector based on the premise that oil and gas stocks could be in danger of overheating. Energy is the 4th most expensive sector going by Shiller’s P/E, and also looks overvalued compared to gold prices.

It’s a sentiment that has also been gaining momentum across Wall Street.

 “Energy traders are confident this oil market will remain tight given the short-term supply outlooks from both OPEC+ and the US, but it has been a steady climb higher. Exhaustion could be settling in,” Ed Moya, senior market analyst at Oanda, has warned.

The concern is [high inflation] could be a forward indicator of consumer habits, and even though gasoline demand is strong now, it’s a sign in the future that if gasoline prices don’t stabilize then consumers will be cutting back,” Price Futures analyst Phil Flynn has told CNBC when discussing record gas prices.

Luckily, there are still bargains to be had in the space, with, Ovintiv Inc.(NYSE:OVV), Civitas Resources, Inc. (NYSE:CIVI), Enerplus Corporation (NYSE:ERF)(TSX:ERF), Occidental Petroleum Corporation (NYSE:OXY) and Canadian Natural Resources Limited (NYSE:CNQ) being among the cheapest energy stocks.

That said, investors might want to know how the current oil price rally compares to the 2014 rally when prices touched $100/barrel for the first time ever.

The chart below compares current oil and gas highs (blue dots) with 2014 highs, which are set as the baseline at 100%. 

From the chart, the broader energy sector S&P Energy Select Sector Index (IXE)

is trading just shy of 2014 levels. However, its two biggest constituents, ExxonMobil (NYSE:XOM) and Chevron Corp. (NYSE:CVX), represent ~23% and 20% of the IXE by weighting, respectively, are trading at par with (Exxon) or above (Chevron) 2014 levels.

However, OilField ServicesMLPsOil & Gas Producers, and Midstream are all trading at considerable discounts to their 2014 highs. Oilfield services appear to be the most undervalued, with the sector trading at a massive 70%+ discount relative to the 2014 zenith.

Source: Nasdaq

Oilfield Recovery

OFS stocks were already flying high long before the Ukraine crisis.

The shift has been most evident in the employment market, with OFS firms hiring once again.

OFS companies have reported that drilling and well completion activity, as well as pricing, have been edging higher, while roughnecks are also saying they are seeing an increase in job offers. Oilfield workers were some of the hardest-hit demographic by the Covid-19 pandemic in 2020. Nationally, the oil and gas industry is estimated to have lost 107,000 jobs as per global consulting firm Deloitte, with an estimated 200,000 roughnecks losing their jobs at the height of the global lockdowns.

According to the trade group Energy Workforce & Technology Council (Council), U.S. oilfield jobs have been increasing over the past year.

Prices are expected to soon follow suit. Pricing power is returning in niches like high-spec onshore drilling rigs, with day rates for such U.S. rigs already have seen a $1,000 per day increase with more to come. 

Halliburton, Schlumberger, and Baker Hughes have become the first OFS victims of the Ukraine crisis due to their sheer size and brand recognition. However, Rystad Energy’s head of energy services research Audun Martinsen has told the Financial Times that their smaller peers could continue operating under the radar because they are not directly exploiting or exporting oil and natural resources.

Here are three OFS stocks to keep on your radar amid the last great American oil boom.

Halliburton Co

 Market Cap: $33.9B

YTD Returns: 40.5%

One of the largest oil field services companies, Texas-based Halliburton Company (NYSE:HAL) provides products and services to the energy industry worldwide, including well completion drilling and evaluation services.

Halliburton provides diverse production solutions in exploration, drilling, production software and data management services to upstream oil companies through its Landmark Software and Services product line. Further, the company’s Testing & Subsea and Project Management product line specializes in reservoir optimization and associated technologies. Thailand’s PTT Exploration and Production and Kuwait Oil Company are among the notable oil and gas companies that awarded Halliburton contracts to implement digital transformation and enhance efficiency and production at their oilfields.

Halliburton is among the international OFS companies that have been caught in the Russian-Ukraine crossfire. Back in April, Halliburton announced that it had immediately suspended future business in Russia and is winding down remaining operations there. Previously, the company had halted all shipments of specific sanctioned parts and products to Russia, though the company says it has no active joint ventures in the country.

Fortunately, HAL is not as heavily exposed to the Russian market, with JPMorgan estimating that it gets only 2% of its revenue from the country.

HAL has an average analyst recommendation of Strong Buy. However, its average price target of $31.84 suggests that many analysts think the stock has limited upside after a torrid runup.

NOV Inc.

Market Cap: $7.2B

 YTD Returns: 18.4%

Texas-based NOV Inc. (NYSE:NOV) is a leading worldwide provider of equipment and components used in oil and gas drilling and production operations, oilfield services, and supply chain integration services to the upstream oil and gas industry. NOV was formerly known as  National Oilwell Varco.

Wall Street has been souring on NOV lately, thanks to valuation and supply chain concerns.

Related: U.S. Construction Sector Bolstered By Commercial Projects

Bank of America has issued a double downgrade for NOV shares to Underperform from Buy with a $22 price target (28.7% upside).

Russia is only going to create a tighter global supply chain that could delay the margin recovery story that was core to our bull thesis. We are not 100% confident that Russia developments don’t make sourcing materials like aluminum, copper, nickel, and steel more problematic for a company that was already struggling with its supply chain and material cost inflation,” BofA’s Chase Mulvehill has written.

Citi analyst Scott Gruber has downgraded NOV and Cactus (NYSE:WHD) to hold, citing recent outperformance and supply chain challenges. However, NOV’s 52-week gain of 43.7% appears relatively tame compared to WHD’s 85.1%. 

Meanwhile, Gruber has upgraded Nabors (NYSE:NBR) to hold, as global exposure and rig rate improvement killed its free cash flow bear thesis.

Precision Drilling Corp.

Market Cap: $1.0B

YTD Returns: 80.5%

Precision Drilling Corporation (NYSE:PDS) is a Canada-based company, which is a provider of contract drilling and completion and production services primarily to oil and natural gas exploration and production companies in Canada, the United States and certain international locations.

BMO Capital Markets has dished out upgrades to a number of Canadian oilfield services companies including Precision Drilling Corporation, CES Energy Solutions Corp. (OTCPK:CESDEF), Pason Systems Inc. (OTCPK:PSYTF), and Secure Energy Services Inc. (OTCPK:SECYF) as drilling activity ramps up.

“We believe the sector is on the verge of a multi-year run in activity levels, while pricing continues to trend higher,” John Gibson, an analyst with BMO Capital Markets, has written in a note to clients titled “Glory Days Ahead, but Expect Volatility to Continue.”

Gibson says Precision, CES, and Pason each exhibit high market share across North America, leverage to rising activity levels and strong free cash flow generating capabilities.

Another key attraction: is low leverage.

Precision Drilling is aggressively paying down its debt and says its debt reduction plans will continue with the goal of repaying more than $400M in debt over the next four years and reaching a sustained net debt to adjusted EBITDA ratio of below 1.5x. Precision managed to reduce total debt by $115M in 2021, and, by 2025, expects to have reduced debt by more than $1B since 2018.

But that won’t come at the expense of shareholders: Precision also says it plans to allocate 10%-20% of free cash flow before debt principal repayments toward the return of capital to shareholders.

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