The offshore drilling sector has suffered through the crisis, and there has been no respite even for onshore drilling companies. Patterson-UTI Energy (PTEN, Financial) slumped to $11.49 on Jan. 25 from a high of $22.6 in the last year.
Subsequently, the stock has trended higher by 60% to current levels of $18.43. While the upside in the last month and half has been significant, I still remain bullish on the stock.
Coming to the factors to be bullish on Patterson-UTI Energy, the stock trades at fiscal year 2016 and fiscal year 2017 EV/EBITDA of 7.2 and 6.6 even after 60% upside from all-time lows. The stock has surged from oversold levels, and valuations are not expensive after the recent upside.
The second reason to be bullish on Patterson-UTI Energy is the recent upside in oil prices, which is likely to continue. There is likely to be a production freeze by major oil producers and a weak dollar will also support oil prices. I am bearish on the dollar as I expect no further rate hike in 2016, and economic weakness can translate into renewed QE.
The third reason is the most important to be bullish on Patterson-UTI Energy. Most oil and gas companies have declared fourth quarter 2015 results and their initial guidance for 2016. The guidance puts into perspective the likely demand for onshore rigs through 2016. Therefore, the stock has discounted any weak demand concerns and the upside in the recent past indicates that market participants were excessively bearish for the year.
For January, Patterson-UTI Energy had 78 rigs operating in the U.S.; the operating rigs declined to 70 for February. However, I expect the decline to moderate in the coming months. Further, in an optimistic scenario (oil continues to trend higher), I expect the rig count to increase as oil and gas companies expand their conservative capital expenditure program. However, the optimistic scenario is likely to play out only if oil continues to trend higher and sustains above $40 per barrel.
Besides these industry factors that are supportive for the near term, I like Patterson-UTI Energy for the following reasons from a long-term perspective:
- The company has a quality fleet with 161 Apex rigs, and these rigs will find contracts as soon as there is sustained recovery in the industry. A majority of the company’s EBITDA comes from Apex rigs.
- The company has a good balance sheet profile with extended debt maturity and debt to capitalization of 25%. I see no credit-related concerns even if challenging industry conditions sustain in 2016.
- Patterson-UTI Energy has strong financial flexibility with $113 million in cash and $500 million in undrawn credit facility. With the company expecting $190 million in capital expenditure for 2016, the company’s investment is fully financed through internal cash flows.
While these are some key positives, EBITDA margin compression is one risk factor for 2016 and beyond. The company’s EBITDA margin for fourth quarter 2015 was 29.1% as compared to an EBITDA margin of 31.8% for fourth quarter 2014. As term contracts are signed in 2016 and beyond, further EBITDA margin compression on relatively lower day rates can be expected.
Patterson-UTI Energy is interesting from a long-term investment perspective. Even from a trading perspective, there can be more upside in the foreseeable future if oil continues to trend higher.
Disclosure: No positions in the stock.
