2 Energy Stocks With 40% Upside — or More
I’m always looking for stocks that have a chance to make a solid upward move in several quarters or several years. But sometimes, you catch a break and can bag some upside much more quickly than that.
At the end of January, I suggested that shares of Sandridge Energy (NYSE: SD) looked more appealing than energy giant ExxonMobil (NYSE: XOM), predicting that shares would rise 40% to $10 “over the course of 2011.” One month later, shares have already surpassed that target, and it’s already time to take profits.
Time to re-deploy
If you bagged profits with Sandridge Energy, I’ve spotted a new pair of names that may be poised to break out and could be worthy beneficiaries of your investing dollars.
[More from David Sterman: "2 Picks from an Investment Pro with 20% Annual Gains"]
My current choices: Parker Drilling (NYSE: PKD) and Newpark Resources (NYSE: NR). Both these firms should benefit from an expected rebound in drilling activity in the Gulf.
Texas-based Newpark Resources is the “Home Depot” of the gas drilling industry. The company sells or rents a wide range of products such as drilling fluids, drilling mats (that enable equipment to traverse across soggy sea floor beds) and a range of environmental clean-up services used by drillers. Business has been pretty good while the Gulf has been in shutdown mode, thanks to an expansion into Brazil and elsewhere, but Newpark still generates more than 50% of sales in the United States. By my math, international business is likely to remain solid in 2011 and U.S. business should rebound nicely.
As an added kicker, Newpark could benefit from federal decisions to restrict the use of harmful chemicals in onshore natural gas drilling, known as “hydrofracking” (which was the focus of “Gasland,” a Best Documentary nominee at the Oscars and the focus of a major article in The New York Times Sunday). Newpark offers a proprietary technology that uses mud instead.
Newpark on Feb. 17 released impressive fourth-quarter results, which helped shares to the $7 mark for the first time since November. Back then, shares plunged from $9 to $5.50 on concerns that the company’s profitable Gulf of Mexico clean-up business was drying up. Investors mistakenly assumed that Newpark’s other businesses would take some time to pick up the slack. But with Gulf drilling activity set to rebound and the rest of the company’s divisions firing on all cylinders, that pessimism proved costly to those who sold off shares after they plunged in November.
In coming weeks, I expect analysts to re-visit their earnings models, taking their outlooks up just as fast as they took them down a few months ago. Right now, analysts are looking for roughly $0.55 a share in earnings (EPS) this year and $0.65 in 2012, though I expect to see each of those forecasts to be upwardly revised by about $0.10.
Rising activity in the energy sector could enable Newpark to generate higher pricing for its goods and services, and when that happens, look for analysts to apply a more robust target multiple on the stock. A forward multiple of 14 on my 2012 view of $0.75 in EPS could push the shares north of $10. The shares currently trade around $7. That’s 40% upside.
Parker Drilling, another Texas company, is also likely to see a boost from higher drilling activity in the Gulf, augmenting its U.S. land-based and international segments. The company rents a wide range of tools used by drillers, from basic hardware all the way up to complex deep-water rigs. (One of its rigs just drilled down to an impressive seven-mile depth, which the company believes to be a record.) Parker’s business is further diversified by its role in the design and construction of drilling rigs for other customers.
Rig-building can be an expensive business: Parker Drilling’s capital spending nearly doubled in 2010 to $219 million. That has been a real concern when you note that the company carries more than $400 million in long-term debt. Total debt stands at 45% of the company’s capitalization. Yet as results start to strengthen, thanks in part to a re-opening of Gulf drilling activity, cash flow should move nicely higher and put any debt concerns to rest.
EBITDA has fallen the past few years, from $274 million in 2007 to just $153 million in 2010. As pricing and demand strengthen in 2011 and 2012, that metric should move back up above $200 million and approach the $250 million mark by 2012 or 2013. Rising EBITDA should help Parker Drilling to pay down some debt, moving the debt-to-capital ratio well lower. As that brighter outlook comes into focus, shares could rally in advance. From a current $5.25, I see a possible move of more than 50% up to $8 (which is still below the $10 to $12 range seen in the middle of the past decade).
Action to Take –> These are highly cyclical stocks that appear to be entering the sweet spot of their cycles. They each look to have solid 30% to 50% upside in the next 12 months and perhaps even more if you’ve got a multi-year time horizon.
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