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Insiders Troll the Oil Services Sector Carnage for Big Profits

By Michael Brush
Exclusively for InvestorIdeas.com
September 21, 2006

With the price of oil continuing to slip, the shares of companies that supply the rigs, drill bits and services to the big energy producers have been hit hard.

Investors worry that if energy prices drop too much, producers will cut back sharply on exploration and production – forcing oilfield services companies to mothball expensive equipment.

That would crush profit margins and hurt these oilfield services stocks even more than they’ve already been damaged. So investors are tripping over each other to get out now.

But some energy sector experts believe the selling is overdone, and it’s now time to take the other side of the trade for two reasons.

The stocks look really cheap. The Philadelphia Stock Exchange Oil Service Sector index trades for about 10.3 times next year’s expected earnings. That’s less than the prior trough of 11 times expected earnings in September 2001 – even though oil sold for way less back then, or about $23 a barrel. Oil recently sold for around $61 a barrel.
Oil won’t fall enough to hurt these names. Oil would have to slip below $40 a barrel for energy companies to cut back significantly on exploration and production, says Tim Parker, an oil services sector analyst with the mutual fund group T. Rowe Price.

But oil is not likely to go that low. Demand from a robust global economy is too strong, especially from white-hot growth countries like India and China. What’s more, energy will continue to carry a significant risk premium because of possible supply disruptions in the Middle East. Energy analysts I trust don’t see oil going below $55 a barrel.

The conclusion: Now is the time to step up and buy oilfield services stocks. And the insiders agree wholeheartedly. They’ve bought significant amounts of at least two oilfield services companies in the current weakness.

At Weatherford International (WFT), director Robert Millard purchased $2 million worth of stock for $39.94 a share earlier this month. Management already has big exposure to the stock. Chairman and chief executive Bernard Duroc-Danner owns over $25 million worth. Overall, top executives and board members own 2.6% of the outstanding shares.
At Oil States International (OIS), directors and a senior vice president for accounting purchased over $500,000 worth of stock for roughly $27-$30 earlier this month. The company also recently upped its buyback program by $50 million to $100 million.

Here’s a closer look at these companies.

Weatherford International

Based in Houston, TX, this drilling services company actually does most of its business outside of North America -- in the Eastern Hemisphere.

That’s a good thing, because more than 85% of the world's proven oil and natural-gas reserves are in that part of the world, says Morningstar analyst Matt Moran. So Weatherford’s strong presence with service and manufacturing centers in the Middle East, North Africa and the Caspian Sea will pay handsome dividends, he says.

Weatherford’s revenue in the Eastern Hemisphere will grow 40%-50% next year, says Calyon Securities analyst Mark Urness. Overall, the company should see 30% sales growth next year and in 2008. That’s pretty healthy growth for a company whose stock has been hammered so hard. Since early May its shares have fallen 35% to trade recently at around $38.

Weatherford offers drilling tools and energy production services, especially for use in mature wells. The company’s prolific spending on research means its offerings have a decidedly a high-tech twist. It invests approximately 2.4% of revenue on research and development. So it holds its own against bigger competitors in the space like Schlumberger (SLB), even though it is one fifth the size.

Lots of spending on tech is crucial, because oil and gas producers increasingly look in obscure places to satisfy the world’s thirst for energy. If not, they are likely to be using wells that are more than 20 years old and in rapid decline, says Morningstar’s Moran. Both situations call for the sophisticated kind of production technology that Weatherford can offer.

The company also adds to its technology base through acquisitions – recently through the purchase of the technology division of Precision Drilling Trust (PDS). Weatherford also uses its solid cash flow to buy back lots of stock. Calyon Securities’ Urness has a $64 price target on the shares, for a 68% gain if you buy now.

Oil States International

Oil States International offers an eclectic assortment of products and services to oil producers. Two main business lines are:

Deep-water drilling products like moorings that connect floating offshore rigs to systems that bring oil or gas up from the ocean floor.
Construction of accommodations for workers on Canadian oil sands projects.

Both of these businesses are strong.

But the company has some shortcomings, too. First, it has limited exposure to international energy production where growth is stronger than in North America. It also has a lower-growth tubular distribution business that accounts for half of revenue.

Still at $26 a share, the company’s stock “verges on the ridiculously cheap,” says Parker, at T. Rowe Price. He thinks the stock could nearly double in the coming years as the oil and gas production cycle plays out. Goldman Sachs analyst Daniel Henriques has a 12-month price target of $41, for a 58% gain for anyone who buys now.

The bottom line: The risk to owning these stocks is world-wide economic recession severe enough to hurt demand for oil. But I doubt the global economy is going to go into recession soon. So I think both of these stocks are a buy right here. Just remember, it’s tough to call the bottom in a significant sell off that’s caused the kind of damage these stocks have seen. So be prepared for volatility if you buy here – and have a time horizon of at least a year.

Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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