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Published: February 5, 2010
The roller coaster-like moves in the energy
sector appear to be ending. Energy prices are no longer too low
to spur the development of oil and gas fields. And they’re not
so high that they will choke off demand for the world’s largest
energy consumers. With an outlook for more stable energy prices
in 2010, you can look for more positive results from the
companies that provide all kinds of services and equipment to
the global oil companies.
Many investors tend to focus on the industry titans such as
Schlumberger (NYSE: SLB) and Halliburton (NYSE: HAL).
They ought to pay closer attention to Weatherford
International (NYSE: WFT), a
mid-cap player that sports strong growth prospects thanks to
recent contract wins.
If you simply look at the North American energy market, you’d
see little reason to be optimistic. Natural gas prices remain
weak and so many new gas fields have recently been discovered
that another spike is very unlikely. Weatherford is feeling this
hit as much as any player: Operating income in North America is
likely to be just $250 million to $300 million in 2010, well
below the $1.2 billion generated in 2008. Yet in the years to
come, spending on natural gas fields should rebound as existing
fields become depleted, supply shrinks and untapped wells get
pulled into service. (Betting on natural gas when prices are
weak can certainly pay off: Amy Calistri
is up +650% this way.)
More importantly, Weatherford is also heavily exposed to the oil
exploration market, which is in the early stages of a rebound --
especially on the international stage. As a result, Weatherford
is poised to see a sharp acceleration in profits. The company is
just now ramping up in Iraq, Russia, Brazil, Saudi Arabia,
Libya, China and elsewhere.
Earlier in the decade, Weatherford wouldn’t have been mentioned
in the same breath as the biggest industry players -- it had a
limited set of products and services to offer customers. But an
acquisition of Precision Drilling in 2005 and a purchase of
BP’s (NYSE: BP) TNK division in 2009 has turned Weatherford
into a full-service shop . Precision brought the company
expertise in the area of oil and gas well drilling, while TNK
had considerable exposure to the burgeoning Russian energy
market. These deals have fueled an impressive string of new
contract signings.
Trouble is, those new deals are still in various stages of
development, so the company’s recent fourth-quarter earnings
report was a grab bag of slipped deadlines. Projects that should
have showed substantial progress in the fourth quarter are just
getting started. The company has sought to clear the decks by
taking a series of one-time charges that pushed fourth-quarter
operating results into the red.
To be sure, 2010 still represents a bit of a challenge:
Weatherford is highly-exposed to the Mexican market, which is
characterized by rapidly aging oil fields. Revenues from the
region are falling, but the remaining contracts carry better
profit margins that the contracts that have recently expired. So
Mexican-derived revenues are likely to fall, but profits should
fare better.
Here in the United States, it will likely be several more
quarters before the imbalance between supply and demand for
natural gas comes into balance. When that happens, drilling
activity should begin a multi-year rebound and should help
quarterly profits to move from roughly $0.10 a share in the
current quarter, to the $0.30 to $0.40 range by the fourth
quarter.
The stage could be set for a more robust 2011, when profit
margins should rebound toward recent peaks. During the last five
years, Weatherford’s
EBIT (earnings before
interest and taxes) averaged 18%. A
lot of the company’s equipment sat idle in 2009, and it fell to
just 9%. This is a very capital-intensive business, and margins
can swing sharply if demand slumps even moderately. Yet EBIT
margins should rise steadily through 2010 as all of that dormant
equipment gets put back to work.
Why the brightening outlook? Weatherford acquired BP’s stake in
TNK to gain greater access to the Russian energy market.
Management concedes that it has been a challenge to integrate
TNK into its operations, but expects to post strong results from
that unit in 2011. In addition, the company has already secured
more than $400 million in contracts in Iraq to help the country
rebuild its energy infrastructure. Lastly, energy exploration
efforts in a range of other countries are expected to rebound in
coming quarters, unless we see another precipitous plunge in
global energy prices.
Despite Weatherford's promising outlook, most investors are
squarely focused on the present, leaving the stock price stuck
in the mid-teens. As investors start to look beyond the
near-term noise, shares should again start to merit a
P/E ratio closer to 20 ,
which is a typical valuation in the early stage of the energy
exploration cycle for these companies. Weatherford looks set to
earn $1.25 to $1.50 a share in 2011 , which means the shares
trade for 10 to 13 times projected 2011 profits.
As the accompanying table shows, shares of Weatherford have the
lowest projected P/E ratio in the group, even as earnings are
expected to accelerate.
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If Weatherford's P/E rises back to 20, then shares could hit
$25 to $30 as the industry truly enters an upturn.
-- David Sterman
Contributor
StreetAuthority |
