Helmerich & Payne (HP, Financial) has trended higher by 20% in the last six months; since bottoming out at $42.9 on Jan. 20, the stock has surged by 41% in a month and half. The worst is over for Helmerich & Payne, and the stock is likely to trend higher in the next 12 to 24 months.
Before addressing the bullish factors, Helmerich & Payne was downgraded by Moody’s to Baa1 from A3 on March 3. Further, Moody’s has provided a negative outlook besides the rating downgrade. However, the factors resulting in the downgrade were largely discounted by the stock. No negative stock price action is likely due to the downgrade.
Since the company was recently downgraded, let's start with the company’s balance sheet health. As of December 2015, Helmerich & Payne had $848 million in cash and $545 million in debt. Therefore, the company is net debt free, underscoring the point that fundamentals remain excellent even in the downturn. Further, for fiscal year 2015, the company’s operating cash flow was robust at $308 million; even if the company’s cash flow moderates in 2016, Helmerich & Payne is likely to remain free cash flow positive. Clearly, there are no balance sheet concerns for the company even if the industry conditions remain challenging through 2016.
From an industry perspective, there are two potential reasons to be positive on Helmerich & Payne:
- First, most of the oil and gas companies have issued guidance for 2016, and this provides clarity on the number of operating onshore rigs for the foreseeable future. With this factor discounted in the stock and the stock trending higher, the rally from oversold levels will continue.
- Second, there is speculation of a potential production freeze by major oil-producing countries. If this happens, oil can trend well above $40 per barrel. This will be positive for the onshore drilling industry as companies can revise their investment targets in the second half of 2016.
Besides these factors, it is important to mention that Helmerich & Payne is a leader in the AC Drive rigs industry in the U.S.; with superior rigs and service, the company commands a premium day rate over peers. From a long-term perspective, this is an important consideration for holding Helmerich & Payne.
In the next 12 to 24 months, margin compression in the onshore drilling industry appears likely if oil price recovery is not robust. It would not be surprising to see EBITDA margins for fiscal year 2016 lower than fiscal year 2015. In a competitive market scenario, onshore drillers might prefer to utilize rigs at a lower day rate than keeping the rig idle.
From 2016 cash flow perspective, the key positive for Helmerich & Payne is the fact that a little over 100 rigs are still under term contract; this will ensure steady cash flow. Term contract cancellations will be minimal in 2016 even if oil trends higher gradually. If oil falls below $30 per barrel again, contract cancellations are likely to accelerate. However, oil likely has bottomed out.
Even with these positives, it is important to remember that Helmerich & Payne has 345 available AC Drive rigs and only 121 are contracted as of Jan. 28. Investors should remain cautiously optimistic and avoid a big plunge in this stock or the energy sector.
The upside for Helmerich & Payne can be expected to continue with the company having strong fundamentals and cash flow visibility from term contracts. The worst probably is over for the onshore drilling services industry.
Disclosure: No positions in the stock
