The Zacks Oil and Gas - Drilling industry remains promising for investors despite commodity price fluctuations. While some reduction in activity has occurred due to this volatility, it's expected to stabilize soon. The recent upturn in oil prices could have a positive impact on drilling activity. Strong demand in large oil-rich basins is likely to drive the industry’s growth. Although macroeconomic challenges may lead to occasional activity moderation, the space still holds potential, particularly for companies focusing on growth opportunities and operational efficiency. Investors are encouraged to consider Helmerich & Payne HP, Patterson-UTI Energy PTEN and Seadrill Limited SDRL for investment in this industry.
The Zacks Oil and Gas - Drilling industry consists of companies that provide rigs (or specialized vehicles) 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. Drilling for hydrocarbons is costly and technically difficult, and its future primarily depends on contracting activity and the total number of available rigs at a given time rather than the price of oil or gas. Within the industry, it's interesting to note that the 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. Overall, drilling stocks are among the most volatile in the entire equity market. deep rock well drilling bits
3 Trends Defining the Oil and Gas - Drilling Industry's Future
Activity Outlook Remains Robust: Despite slowing a bit in recent times due to volatility in commodity prices and certain macro factors, activity is expected to improve through the end of the year and in 2024 in North America — a region most drillers depend on. In fact, upstream operators (particularly in North America) are likely to be drilling more wells to increase output that has remained depressed over the past few years due to lack of investment, supply-chain issues, scarcity of labor and equipment attrition. With domestic oil and natural gas output set to increase, drilling companies stand to benefit. As far as the international market is concerned, one can see prospects of perked-up activity across a number of major geographies. Low Replenishment of Reserves Point to Drilling Requirement: One of the key positive arguments for drillers is the focus on the reserve replacement rate. Over the past few years, the supermajors have struggled to replace all of the oil and gas they churn out, raising concerns about future production. In this context, Chevron’s 10-year reserve replacement ratio of 100% indicates the inability to add proved reserves to the amount of oil and gas produced. This clearly calls for a calibrated approach in meeting reserve shortfalls in the long run. Consequently, a gradual improvement in drilling activity looks likely. Dwindling Pool of Legacy, High-Margin Contracts: For most operators, order levels have remained depressed, and day rates are trending just above cash costs despite the strong rebound in commodity prices. This has put increased pressure on their revenue-generating capacity. Further, as the companies’ legacy, high-margin contracts wind down slowly, drillers are faced with the prospect of a drop in backlog (and consequently, revenues), which is likely to accelerate over the next few quarters. This also leaves drillers vulnerable to addressing their massive debt maturities and investment in newbuilds.
Zacks Industry Rank Indicates Positive Outlook
The Zacks Oil and Gas - Drilling industry is a 9-stock group within the broader Zacks Oil - Energy sector. It currently carries a Zacks Industry Rank #91, which places it in the top 36% of 250 Zacks industries. The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates upbeat 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. Considering the encouraging dynamics of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.
Industry Outperforms Sector & S&P 500
The Zacks Oil and Gas - Drilling industry has fared better than the broader Zacks Oil – Energy sector as well as the Zacks S&P 500 composite over the past year. The industry has gone up 12.5% over this period compared with the broader sector’s increase of 3.6%. Meanwhile, the S&P 500 has gained 6.5%.
Since oil and gas drilling companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of non-cash expenses. On the basis of the trailing 12-month enterprise value-to-EBITDA (EV/EBITDA), the industry is currently trading at 16.73X, higher than the S&P 500’s 12.58X. It is also well above the sector’s trailing-12-month EV/EBITDA of 3.28X. Over the past five years, the industry has traded as high as 24.75X, as low as 7.28X, with a median of 12.51X, as the chart below shows.
3 Oil and Gas - Drilling Stocks to Watch
Seadrill Limited: Seadrill is a market-leading international driller with strong exposure in key strategic basins like the U.S. Gulf of Mexico, Brazil and Angola. Following the Aquadrill LLC acquisition earlier this year, SDRL has improved its cash flow generation potential significantly. A robust balance sheet, enhanced liquidity and credit profile are the other positives in the Seadill story. The company has transformed its capital structure through accretive transactions and continues to deliver operational excellence. The Zacks Consensus Estimate for this offshore driller’s 2023 earnings has been revised 8.5% upward over the past 90 days. SDRL has a trailing four-quarter earnings surprise of roughly 89.2%, on average. Seadrill carries a Zacks Rank #1 (Strong Buy), and its shares have gone up 27.2% in a year. You can see the complete list of today’s Zacks #1 Rank stocks here.
Patterson-UTI Energy: Patterson-UTI Energy's business benefits from its proprietary design and technologically advanced Apex rigs that can move faster than conventional rigs, drill quicker and are better suited to new-age drilling. Meanwhile, the company's acquisition of Pioneer Energy Services has boosted its scale and geographic presence. Further, following the September 2023 merger with NexTier Oilfield Solutions, Patterson-UTI has become a leading provider of drilling and completions services in the United States. The 2023 Zacks Consensus Estimate for this Houston, TX-based company indicates 124.6% earnings per share growth over 2022. PTEN currently carries a Zacks Rank #2 (Buy). The stock has lost 35.6% in a year.
Helmerich & Payne: Helmerich & Payne is engaged in the contract drilling of oil and gas wells in the United States & internationally. Its technologically advanced FlexRigs are much in demand. The Zacks Rank #3 (Hold) company has already upgraded most of its drilling fleet with the latest technology. Besides, Helmerich & Payne boasts a strong balance sheet, carrying little long-term debt. With available liquidity surpassing debt levels and no significant near-term maturities, Helmerich & Payne should sail through any difficult operating environment. The fiscal 2024 Zacks Consensus Estimate for HP indicates 33.8% revenue growth over the previous year. The company beat the Zacks Consensus Estimate for earnings thrice in the trailing four quarters and missed in the other. The Helmerich & Payne stock has lost 25.2% in a year.
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