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Steady Near-Term Outlook for Oil & Gas Drilling Industry

Nilanjan Choudhury
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Steady Near-Term Outlook for Oil & Gas Drilling Industry

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:
 

  • With oil prices surging almost 200% from the dark days of February 2016, work for drillers – particularly onshore – has picked up 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. This has led to huge demand for new premium land rigs. With crude prices expected to remain strong going into the back end of the year and surging shale output, growth prospects for land drillers look strong.   
     
  • On the other hand, high 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 rising 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 long term. This could increase demand for offshore drilling rigs.  
     
  • 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 Rank Indicates Solid Prospects

The Zacks Oil and Gas - Drilling Industry is a 16-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #111, which places it in the top 43% 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 steady 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 for your portfolio, 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 2.9% over this period compared to the S&P 500’s rise of 5.3% and broader sector’s fall of 0.8%.

One-Year Price Performance

 

 

Industry’s Current Valuation  

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing oil and gas drilling stocks, the industry is currently trading at 12.13X compared to the S&P 500’s 10.87X. It is also above the sector’s trailing-12-month EV/EBITDA of 5.69X.

Over the past five years, the industry has traded as high as 13.95X, as low as 3.93X and at the median of 6.96X, as the chart below shows.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

 

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

 

 

Bottom Line

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 future 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.

None of the stocks in the Oil and Gas - Drilling space currently sport a Zacks Rank #1 (Strong Buy). However, we are presenting a stock with a Zacks Rank #2 (Buy) that is well positioned to grow amid challenges. There are also 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): For this Tulsa, OK-based driller, the Zacks Consensus Estimate for the current-fiscal EPS has been revised 150% upward over the last 30 days. Moreover, this Zacks Rank #2 stock has solid expected earnings growth of 107.9% for the current fiscal year.

Price and Consensus: HP

 

Independence Contract Drilling, Inc. (ICD): This Houston, TX-based company has an attractive expected earnings growth of 58.5% for the current year. The driller carries a Zacks Rank #3 and has an average positive earnings surprise of 5.9% for the trailing four quarters.

Price and Consensus: ICD

 

Transocean Ltd. (RIG): This Switzerland-headquartered driller delivered an average positive earnings surprise of 55.2% in the trailing four quarters. The Zacks Consensus Estimate for current-year earnings of this Zacks Rank #3 stock has moved up 6.6% over the past 60 days.

Price and Consensus: RIG

 

Pioneer Energy Services(PES): The 2018 Zacks Consensus Estimate for this Houston, TX-based company represents some 18.6% EPS growth over 2017. Next year’s average forecast points to further 44.5% growth. Pioneer Energy Services has a Zacks Rank #3.

Price and Consensus: PES

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Transocean Ltd. (RIG) : Free Stock Analysis Report
 
Pioneer Energy Services Corp. (PES) : Free Stock Analysis Report
 
Independence Contract Drilling, Inc. (ICD) : Free Stock Analysis Report
 
Helmerich & Payne, Inc. (HP) : Free Stock Analysis Report
 
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