Recently, I wrote about setting up a GuruFocus All-In-One screener that would find undervalued predictable stocks with no debt. The criteria were fairly stringent: no long-term debt at all, at least a 4.0 Star predictability rating, a PEG valuation of less than 1.5 and owned by at least one guru. Only five stocks among the thousands listed met that criteria and one of them was Dril-Quip Inc. (DRQ).
To my surprise, this no-debt, high quality stock is in the oil and gas industry, which has not seen much good news in the past couple of years. This chart shows DRQ’s share price (green) and revenue (blue line) over the past two decades:
In this article, we will take a closer look at Dril-Quip and ask if it should be on our radar as we wait for oil prices to pick up again.
History
1981: Founding of the company, by four partners, in Houston, TX.
1983: Opening of a European Division in Scotland.
1990: Setting up a sales, service and manufacturing facility in Singapore.
1997: Going public on the New York Stock Exchange, symbol DRQ.
History based on information at Reference for Business.
Dril-Quip’s Business
The company designs, manufactures, sells and services offshore drilling and production equipment. This highly-engineered equipment is used in deepwater, harsh environment and severe service applications (unless otherwise noted, all information in this section comes from the company’s 10-K for 2015).
Its main products and services are:
- subsea and surface wellheads;
- subsea and surface production trees;
- subsea control systems and manifolds;
- mudline hanger systems;
- specialty connectors and associated pipe, as well as drilling and production riser systems, liner hangers, wellhead connectors and diverters;
- technical advisory assistance and rental and service revenues for rework and reconditioning services.
Customers include major companies, whether integrated or independent, as well as foreign and national oil and gas companies. What they all have in common is offshore operations (around the world).
Dril-Quip says it has developed its equipment line mainly through its own product research and development efforts.
Comments: DRQ is a 35-year old company that specializes in designing, manufacturing and marketing offshore drilling equipment for the oil and gas industry.
Revenue
As this table from the 10-K for 2015 shows, more than 4/5ths of its revenue originates with products, while services provide slightly less than 1/5th:
Within the products segment, Subsea accounts for the lion’s share of revenue, while surface equipment and oil rig equipment are a distant second and third:
The company does not depend heavily on any particular customer. It said, “In 2015 and 2014, the Company’s top 15 customers represented approximately 61% of total revenues and Chevron and its affiliated companies accounted for approximately 12% and 10%, respectively, of total revenues.”
Backlogged orders at the end of 2015 were down 43% from the year before, from $1.2-billion at the end of 2014 to $685-million at the end of last year.
Comments: DRQ is a specialist in offshore drilling equipment, but even within that segment it specializes as a developer of subsea products (versus surface and oil rig equipment).
Competition
Dril-Quip says it faces “significant competition” from others in the industry. In addition, some of those competitors are diversified—and bigger—multinationals.
Named competitors are GE Oil and Gas (GE, Financial), formerly Vetco Gray and production equipment segments of OneSubsea (a Schlumberger Ltd. (SLB, Financial)/Cameron International Corporation (CAM, Financial) joint venture), FMC Technologies Inc. (FMC, Financial) and Aker Solutions (AKSO, Financial).
Comments: Offshore oil and gas drilling is a capital intensive sector and the players in it need size, connections, or good survival instincts to survive in it.
Moat
DRQ has a system for product development:
- It tries to design the most advanced version of an application -- to establish its reputation and qualification in that product;
- leverages its expertise in the more advanced product to develop less costly and less complex versions of the product, for less-demanding applications;
- throughout, it tries to reduce the overall costs to the customer, including initial capital cost as well as operating, installation and maintenance costs.
And although Dril-Quip is much smaller than the competitors it names, it does have several financial advantages over them, including its earnings predictability (except for CAM), financial strength, profitability, margins and ROE:
Comments: To sum up the advantages over its competitors, we might simply say it outmanages them.
Growth
Having said that and knowing oil prices remain depressed, what are we to think of Dril-Quip’s potential growth?
The company argues, in a presentation to the J.P. Morgan Inaugural Energy Equity Conference on June 27, that its sector of the oil and gas industry does have a future:
Looking at its own future, Dril-Quip summed up its future this way at the conference:
Comments: Although oil prices remain low, offshore operations are sure to continue because of demand and the need for reserves replacement, while costs should ratchet down. As for the company, it sees opportunities for acquisitions and new product development, while returning cash to shareholders.
Ownership
GuruFocus reports that six of the gurus it follows own stakes in Dril-Quip. The biggest holding is that of Ken Fisher (Trades, Portfolio), who owns 377,326 shares. He is followed by Jim Simons (Trades, Portfolio) and RS Investment Management (Trades, Portfolio).
It also shows very high ownership by institutional investors and insiders, with a good representation by shorts as well:
Comments: We rarely see such a high proportion of ownership by the pension and mutual fund professionals, presumably some of their shares have also been loaned out to the shorts.
Other
Dril-Quip Inc. incorporated in Delaware and has its headquarters in Houston, Texas.
Blake T. DeBerry, age 56, has served as president, CEO and director since 2011. He held various engineering and management positions after joining the company in 1988.
John V. Lovoi, age 55, has been the Independent Chairman of the Board of Dril-Quip Inc. since 2011. He is the Managing Partner of JVL Advisors LLC, a private energy investment company (biographical information from reuters.com).
As of December 31, 2015, the employee count stood at 2,319, including 1,246 in the United States.
DRQ by the Numbers
Comments: A relatively small-cap company with a share price roughly halfway between its 52-week high and low. Modest P/E, good ROE considering the industry it is in, and was able to buy back 3% of its shares last year.
Financial Strength
Dril-Quip earns exceptionally good ratings for both financial strength and profitability and growth. That is especially remarkable considering it is in the oil and gas industry:
Lots of green on these icons, although I suspect we will see less a year from now, assuming lag time between the decline in oil prices and bottom-line results at DRQ.
No debt, of course, and we also see that Return on Invested Capital is several times greater than the Weighted Average Cost of Capital.
This revenue chart shows that the decline in oil prices has caught up to DRQ:
Nevertheless, its free cash flow has continued to grow since bottoming out in fiscal 2012:
Like revenue, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) has taken a dip in the past year:
And the results show in its EPS (Earnings Per Share):
Comments: Overall Dril-Quip is feeling the pressure of depressed oil prices, with lower revenue, EBITDA and EPS, but it remains debt-free.
Valuations
Again, its tough to think of this as an oil company. Check out the GuruFocus valuations, almost all of which position the stock as underpriced:
On valuations, GuruFocus suggests, “Dril-Quip Inc is more suitable for Earning Power Based valuation methods. This includes 1) Median P/S Value 2) Peter Lynch Fair Value. The Median P/S Value of Dril-Quip Inc for today is 73.98. The Peter Lynch Fair Value of Dril-Quip Inc for today is 79.32.”
The DCF (Discounted Cash Flow) Fair Value calculator puts Dril-Quip’s intrinsic value at $81.81, 30% above its current price.
Turning to P/E, GuruFocus sees Dril-Quip this way, “NYSE:DRQ's P/E Ratio(ttm) is ranked higher than 55% of the 92 Companies in the Global Oil & Gas Equipment & Services industry. (Industry Median: 15.00 vs. NYSE:DRQ: 12.66)"
It’s much the same story in GuruFocus’ assessment of DRQ’s PEG ratio, “NYSE:DRQ's PEG is ranked higher than 61% of the 38 Companies in the Global Oil & Gas Equipment & Services industry. (Industry Median: 1.81 vs. NYSE:DRQ: 0.74)"
Finally, we note that Dril-Quip enjoys a 4.5 (out of 5) Star rating for predictability, which is very good. This means the company has consistently increased its EBITDA for the past ten years, which should eventually be reflected in the share price.
Comments: A valuation in the high $70s or low $80s seems reasonable for DRQ, which has a strong history of earnings growth.
Conclusion
With its clean balance sheet and a strong earnings history, Dril-Quip is an attractive prospect for investors seeking capital gains.
The big question, though, is the price of oil. In its 10-K for 2015, the company says,
“Both the market for offshore drilling and production equipment and services and the Company’s business are substantially dependent on the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore.”
Bolder investors might buy now, while the share price remains relatively flat, but for the rest of us, this would be a name we keep in our pockets until we see a sustained uptrend in the price of oil.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the foreseeable future.
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