Credit Suisse (CS, Financial) recently opined that all land drillers look overvalued, and Helmerich & Payne (HP, Financial) was downgraded among other drillers. With oil prices gradually trending higher after bottoming out in January, here are the positives and concerns related to considering exposure to Helmerich & Payne.
The rise in oil prices in the last few months does not necessarily imply that rig activity will increase in sync. If oil trends higher and sustains at higher levels, it is likely that onshore rig count increases. That point is supported by two important observations:
- Oil has been trending higher since January, but the total land rig count in the U.S. has continued to trend lower. While the pace of decline has been muted during this period, the decline in rig count clearly indicates that exploration companies remain cautious and budgets are still tight.
- Specific to Helmerich & Payne, the company’s active rig count as of March was 94 with 12 rigs in the spot market, 77 rigs under term contract and five rigs for delivery under term contract. However, as of May 2 (last investor presentation), the company’s active rig count declined to 84 with seven rigs in spot markets, 72 rigs under term contract and five rigs for delivery under term contract. Clearly, even with oil trending higher, the company’s active rigs continue to decline.
Another industry-specific factor that needs to be taken into consideration is the point that the U.S. jobs report was gloomy in May and indicates weakening economic activity and not just for the U.S. Economic activity has been sluggish globally and the implication will be on consumption growth for oil. Therefore, it is entirely likely that exploration companies will keep their investment budgets conservative considering the economic outlook.
The implications of a prolonged period of industry weakness is likely to be lower spot rates and term contract rates for land rigs. In the coming quarters, this is likely to be evident in the form of EBITDA margin compression. This is potentially the reason for Credit Suisse being concerned about valuations as forward EV/EBITDA valuations might not justify current stock price trend.
While these are the concerns and the factors that can potentially keep the stock sideways or lower, there are several positives specific to the company that make Helmerich & Payne worth considering on every decline.
Helmerich & Payne currently offers a dividend of $2.75 per share, and this payout is sustainable in the coming quarters. Attractive dividends are one of the important reasons to be bullish on the stock.
With debt to capitalization of just 10%, Helmerich & Payne is well positioned from a balance sheet perspective on a stand-alone basis and also as compared to peers. Even if challenging times continue, Helmerich & Payne’s balance sheet and credit health are unlikely to worsen.
From an asset quality perspective, Helmerich & Payne is the leader in U.S. land AC drive rigs, and this positions the company ahead of peers. When onshore industry conditions eventually recover, Helmerich & Payne is likely to witness swift recovery as compared to peers.
For fiscal year 2016, Helmerich & Payne is still likely to have more than 70 rigs under term contract; for fiscal year 2017 the number of rigs under term contract is likely to be around 60. Cash flow will remain decent on term contracts even if industry recovery is slow.
Overall, considering all the positives and concerns, investors should wait on the sidelines before considering fresh exposure to Helmerich & Payne. If the stock corrects by 10% to 20% from current levels, it is an excellent buying opportunity for the long term.
Disclosure: No positions in the stock.
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