Despite recent hiccups, the sentiment in the oil market is undoubtedly better than this time last year. Oil price has gone up significantly and we expect the commodity to display more improvement going forward. In such a scenario, investors may take a look at stocks from the energy sector engaged in upstream operations as these companies are likely to be the biggest gainers.
OPEC oil cartel’s November deal to cut output – a long awaited step in reducing the glut of crude – primarily fuelled the rally. The historic agreement, together with help from non-OPEC producers and slashing investments (in existing and new wells) have seen oil prices more than double from their last February lows to around $50 a barrel. Analysts now expect the OPEC deal to be extended beyond Jun 2017, further strengthening oil prices.
It goes without saying that improvement in oil prices will boost the overall upstream business, in turn, generating more lucrative returns for investors.
What Lies Ahead for Oil Field Services & Drilling Industries?
Upstream operations comprise both Oil & Gas-Field Services industry and Oil & Gas-Drilling industry. The most important factor to be considered is that the fate of both these industries are positively correlated to oil prices. Given that oil is advancing, the prospects of both these industries should improve.
Oil & Gas Field Services Industry
The companies belonging to this industry primarily support drilling players in efficiently setting up oil and gas wells. These firms are mainly engaged in manufacturing, repairing and maintaining equipment required for pumping oil out of ground.
Schlumberger Limited SLB, Halliburton Company HAL, Baker Hughes Inc. BHI and Weatherford International plc WFT are four of the premier oil field services companies. These companies together are often referred to as the ‘Big Four.’
Oil & Gas Drilling Industry
Firms belonging to this industry are involved in pumping and drilling oil out of the prospective oil plays. Demand for the services offered by this industry is always high and the expertise of using equipment to drill oil is expensive. Hence, it is not feasible for oil companies to employ these personnel throughout the year. As a result, oil drillers are contracted by energy firms for a specific period of time.
Drilling companies with good fundamentals include Precision Drilling Corporation PDS and Patterson-UTI Energy, Inc. PTEN. Both these companies carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
We have employed a few parameters for an in-depth analysis of both the industries. Let’s analyze the factors.
In terms of Zacks Industry Rank, both Oil & Gas-Field Services industry and Oil & Gas-Drilling industry are among the top performing industries.
Oil Field Services industry is ranked #105 and lies in the top 40% of industries. The Drilling industry, on the other hand, is ranked #96 and lies in the top 36% of industries.
Both the industries have good industry ranks as the top 50% of the Zacks Ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Compared to Oil & Gas-Field Services industry the Oil & Gas-Drilling industry is undervalued. This implies that the Drilling industry has more potential to grow in the near future compared to Oil Field Services industry. The Drilling industry has an average trailing 12-month EV/EBITDA ratio – one of the best multiples for valuing oil and gas companies because these energy firms have a large amount of debt and EV (Enterprise Value) – of 4.69, which is below the Oil Field Services industry’s average of 11.33.
Upon comparing with the S&P 500, we can clearly see that the Oil Field Services industry is overvalued, while the Drilling industry is undervalued. In details, the average trailing 12-month EV/EBITDA ratio for S&P 500 Index is 9.89, which is lower than the Oil Field Services industry’s average but higher than Drilling industry’s ratio.
Return on Capital
Return on Capital (ROC) is another parameter to be considered by energy investors as oil and gas energy sector involves huge investment or capital expenditure.
Over the prior one year, the average ROC for Oil & Gas-Field Services industry was almost 3% as against 3.4% return for the Drilling industry.
We note that the debt levels both the aforesaid industries are completely different. Our proprietary database shows that long-term debt for the Oil & Gas-Field Services industry has been increasing sharply over the last one year.
The long-term debt for the Oil & Gas-Drilling industry, however, has been decreasing steadily over the aforesaid time period.
Earnings before interest, tax, depreciation and amortization (EBITDA) represent earnings from core operations. This is a vital parameter for determining the profitability of the industry.
As per our proprietary data, the average trailing 12-month EBITDA margin for the Oil & Gas-Field Services industry is 23.3% as against 50.35% for the Oil & Gas-Drilling industry. This indicates that the Drilling industry is more profitable than the Oil Field Services industry.
Over the last year, the Oil & Gas-Field Services industry gained 14.2% compared with only 3.5% improvement for the Oil & Gas-Drilling industry.
Hence, the price chart revels that Oil & Gas-Field Services industry has outperformed the Drilling industry.
Dividend yield is among few important parameters that investors usually consider before investing in a particular sector.
The average yield for Oil & Gas-Field Services industry in the last one year was 2.04% as against 1.6% yield for the Oil & Gas-Drilling industry.
The liquidity of a company or industry is determined through current ratio – a measure of the capability of a firm or industry to pay both short- and long-term obligations. The ratio measures current asset relative to current liabilities. Ideally, an industry should have a ratio of more than 1.
Current ratio for Oil & Gas-Field Services industry is 1.87 compared with 1.30 for the Oil & Gas-Drilling industry. Although the ratio for both these industries is more than 1, the Oil Field services industry seems to be more liquid than the Drilling industry.
Apparently, Oil & Gas-Field Services industry has an advantage over theOil & Gas-Drilling industry in certain aspects. Other parameters tilt the scale in favor of Oil & Gas-Drilling industry.
Drilling has a better Industry rank and is more profitable as evident by higher EBITDA margin. Moreover, this industry is undervalued and has more room to run. The debt picture is also in favor of the Drilling industry implying its less reliance on the capital market to invest money for growth opportunities.
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Weatherford International PLC (WFT): Free Stock Analysis Report
Baker Hughes Incorporated (BHI): Free Stock Analysis Report
Schlumberger N.V. (SLB): Free Stock Analysis Report
Halliburton Company (HAL): Free Stock Analysis Report
Patterson-UTI Energy, Inc. (PTEN): Free Stock Analysis Report
Precision Drilling Corporation (PDS): Free Stock Analysis Report
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