On Feb. 14, 1945, King Iban Saud and Franklin D. Roosevelt sat the basis for the relationship between Saudi Arabia and the U.S. At that point, oil had become a key for development and growth in the U.S. economy. Hence, the meeting was of major importance for a country with dwindling reserves, which sat at the top of world coming out of the fiercest of struggles. Today, the Middle East is experiencing a turbulent time, even more disruptive than that experienced during World War II.
North African leaders have been swept by the Arab Spring, Iraq continues down the reconstruction road, and Iran’s market offer is curtailed by major economic sanctions. Meanwhile, changing legislation around the North Sea scares away new investments, while Chinese regulation continues to limit profitability and more important investments. In this context, the interest for unconventional reserves, and their exploitation, took many companies back home. Aided by a gas boom, Patterson-Uti Energy (PTEN, Financial) has seen an increasing demand for its services.
Solid Presence and Performance
An important competitive advantage under the current market conditions for Patterson-Uti Energy is size. It is one of the largest drilling contractors in the U.S. with approximately 279 land-based rigs that operate primarily in the oil and natural gas producing regions of North America. The company also engages in another two activities, however, with a smaller contribution to operating income: pressure pumping (26%), and oil and gas production and exploration (6%). While the first activity is concentrated around the Appalachian Basin, the second is done in west and south Texas, southeastern New Mexico, Utah, and Mississippi.
Four financial institutions have reported on the Patterson-Uti Energy throughout the current month of April. Two of them have rated the stock “Buy,” while the remaining two preferred a more conservative position, “Neutral.” Regardless of the rating, all four coincide on a positive present for the company, a judgment evidenced by target price boosting. Only Morgan Stanley has kept the value below the $30 mark, while the Deutsche Bank peaked at $37 per share. Additionally, earnings have slipped below stock price igniting Peter Lynch’s investment alarm.
For fiscal year 2013, Patterson-Uti Energy reported net income of $188 million, or $1.28 per share, compared to net income of $299 million, or $1.96 per share for the previous year, and revenues were $2.7 billion, compared to $2.7 billion for 2012. The results include a pretax non-cash charge of $37.8 million related to the company's mechanically powered rig fleet, and retirement costs for 48 mechanical drilling rigs. A great responsibility for these results lay on the increment of average rig count from 178 to 187 rigs between December and October.
Not Recommended for the Faint of Heart
Patterson-Uti Energy’s market performance has been impressive during the last two years. The stock recovered the value lost between mid-2011 and mid-2012, attracting new investors and rewarding all ones. Today, the stock trades at 28.1 times its trailing earnings, carrying a 140% percent premium to the industry average. More, it currently pays a $0.1 in quarterly dividends, totaling a 0.77% annual yield. What is more important stock performance is evidently cyclical, suffering from sudden and deep increments and declines.
Additional risks associated with Patterson-Uti Energy are increasing labor costs for contract drilling that lead to slower margin growth going forward. Most important, there is an over availability of land drilling rigs as well as pressure pumping equipment. The effects can be compounded by the volatility of gas prices, and consequential asset liquidation, already experienced in 2002 and 2009. Last, rigs are relatively cheap allowing smaller players to enter and exit the business with few consequences or financial losses.
With all the downsides faced by a long-term investment on Patterson-Uti Energy, the position reduction and exiting done by gurus is fully understood. Hence, although Peter Lynch may recommend at this point to acquire the stock, the advice should be accompanied of several warnings.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.
