PSB Monthly Issue May 2013

However, the truth is we’re experiencing economic growth here and in most of the world – albeit slow growth.  Still, some growth is better than none.

Here’s the thing…

The more the economy grows, the more important energy resources become.  After all, as we grow, we tend to use more energy.  And, we’re willing to pay more to use that energy.

That’s why we like to scan the market for inexpensive opportunities to buy into oil and gas companies.

One way to play oil and gas is to buy drillers.  In particular, if you can find drillers who are in the development stage, they can be cheap stocks with huge upside potential.

However, drillers can be risky.  All kinds of problems and delays may occur when drilling for oil and gas.

That’s where oil & gas equipment and services companies come into the picture.

Oil & gas services companies are not reliant on making the big find or on the production capabilities of one or two key wells.  In fact, drillers need equipment and services no matter what.

As such, equipment and services companies tend to generate more consistent cash flow from quarter to quarter.  And more importantly, it makes it easier for them to turn that cash flow into profits.

One company we really like in this space is Parker Drilling (NYSE: PKD).

THE OIL & GAS EQUIPMENT AND SERVICES BUSINESS

Parker Drilling provides advanced drilling solutions to the energy industry.  The company offers technically innovative products and services on a contract basis to drillers of both oil and natural gas.

PKD’s largest business is land and barge drilling.  Its international fleet includes 24 land rigs and two offshore international barge rigs.  Domestically, the company operates 13 US-based barge rigs, 1 land rig, and 2 Alaskan rigs undergoing commissioning.

Parker’s drilling services are especially useful for geologically difficult wells, such as in harsh, remote, or ecologically sensitive areas.

Moreover, PKD provides rental tools for land and offshore drilling.  The type of equipment offered includes drill pipes, tubing, high-torque connections, blow-out preventers, driller collars, and others.

Finally, Parker also offers project management and technical services.  These range from rig design and construction to operations management.

As we mentioned earlier, these products and services tend to be in demand consistently. While there’s certainly greater demand during boom periods, the business isn’t going to die just because of an economic slowdown.Drillers are going to need equipment and services regardless of what the economy is doing.

And that’s not all…

Parker is aggressively working to expand their international presence.  In fact, the company recently acquired International Tubular Services.

This acquisition adds an international segment to the company’s already robust rental tool business.  Plus, International Tubular already has a strong international customer base.  That’s key because international markets are where the rapid growth is in drilling.

PKD’s business model results in consistent positive operating cash flow.  And, as drilling operations expand domestically and internationally, the company’s going to turn the robust cash flow into strong earnings growth.

THE NUMBERS

Parker Drilling has solid, albeit not spectacular, financial results from the first quarter. The most recent quarter paints a picture of both challenge and hope.  On one hand, year over year numbers are down.  On the other hand, sequential quarterly numbers are up across the board.

Revenues came in at $167 million.  That’s down from the $176 million a year ago, but a sizeable increase over last quarter’s $157 million.  More importantly, March numbers were extremely encouraging, with US barge drilling at full utilization.  It’s the highest average rate since 2008.

Meanwhile, earnings for the quarter were $0.03 per share.  Once again, that’s well under last year’s number but an increase over the previous quarter.  More importantly, it beat analysts’ expectations by a full $0.03.

PKD’s balance sheet is reasonably healthy for a capital equipment heavy business. Cash is sitting at $84 million while long-term debt is at $466 million.  That kind of cash to debt ratio is not unusual for this industry.  Moreover, the company’s current assets are 2.2x current liabilities, which is better than the industry average.

As long as the company continues to generate robust operating cash flow, we have no concerns about PKD’s financial wellbeing.

INVESTMENT RISKS

As with any investment, PKD does have a few risks.

An unexpected slowdown in the economy could reduce demand for PKD’s drilling services and hurt revenue generation.

Competitive pricing pressure from other drilling services companies could reduce margins and lower profits.

Finally, if interest rates move higher, it could impact the company’s debt payments negatively and hurt profits.

POTENTIAL RETURN OF 82% OR MORE

PKD has a solid business that is going to continue to be in high demand as drilling for oil and gas ramps up.  What’s more, the company is aggressively expanding into international markets.

Still, even though the company has consistent positive cash flow and is earning profits, the shares are trading at just 8.2x projected earnings.  That’s a bargain price considering analysts expect PKD to grow earnings by 104% next year.

Plus, the stock is trading well below its 200-day and 50-day moving average.  That’s a sign a turnaround could be on the way soon.

Based on our analysis, we see no reason PKD won’t hit its 2012 high of $7.38 a share or more.  Buy the shares now for potential gains of 82% or higher!

ACTION RECOMMENDATION

BUY Parker Drilling (NYSE: PKD) up to $4.50 per share.

Don’t forget your position sizing and stop-loss rules.