Drilling for profits in the oil and gas fields
The stocks that service Canada’s oil and gas fields haven’t been doing well, but these small cap specialists find reasons for hope, and one buy.
It’s beginning to look a lot like Christmas, sort of.
Good things may finally be coming to one beleaguered corner of the Canadian commodities market.
The companies that service the oil and gas fields haven’t had a jolly time of it lately, but higher expectations — or deeper wells — may be on the horizon.
We turn to an independent research firm that surveys oil and gas service stocks regularly for its clients. In its latest update, KeyStone’s Small-Cap Stock Report does not pretend things will be rosy overnight.
Only one of the 29 stocks it surveys is a buy at the moment. But there is reason to expect that things will improve during the coming year.
Under all market conditions, this advisory looks for “pockets of strength” and it has found a few in this troubled sector. In addition to the single buy recommendation, we will look at five other stocks these experts believe are worth following in the months ahead.
But first, what’s wrong and what’s right in the oil (and gas) patch.
Early signs of strength
This advisory’s survey of energy service stocks begins with drilling companies. But it also includes chemical firms (who make drilling fluids), storage companies, construction firms, seismic companies and those who design and make drilling equipment.
A lot of people profit when energy companies are drilling merrily away.
These experts “are starting to see early signs that some strength is returning to this sector.” But reviewing management’s comments from the last quarter, “we find the general outlook for the oil and gas services sector to be quite bleak near term.”
High crude oil prices do not necessarily translate into stepped-up activity in the oil services industry, the advisory points out. And while oil prices are nowhere near their triple-digit highs of 2008, the current price of $72 a barrel is still on the high side historically.
One might logically expect higher prices to lead to greater capital expenditure from the producers. But there is one big problem.
A ‘smoking’ deal
Natural gas is not keeping up its end of the bargain. Nearly all of Canada’s fossil fuel production comes from the Western Canadian Sedimentary Basin (WCSB) that stretches across Alberta and parts of B.C., Saskatchewan, Manitoba and the Northwest Territories.
The basin’s prosperity is closely tied to natural gas. And since gas hit its last peak of over $13.00 per thousand cubic feet in June 2008, it has dwindled down to a low of $2.50 this past August, and then crept back up above $5.00. Today it sits at $5.50.
Unfortunately for the industry, inventories are high and prices must push higher before capital investment rises substantially.
Under those circumstances, the advisory is “even more critical than usual” in examining the balance sheets of the service firms. “Companies with low cash balances and high debt will likely have difficulty meeting financial obligations as their earnings decline or even disappear.”
Companies in the opposite situation are not only in a better position to soldier on, they may also be able to acquire distressed competitors.
“Lastly,” say these experts, “when the sector as a whole is in a state of disrepair, we look to find a ‘smoking’ deal.” They have found one.
Returning capital to investors
One of the few service firms that managed to generate revenue and earnings growth in 2009 is World Point Terminals (TSX-WPO). This storage company owns over 10 million barrels of oil storage, blending and transshipping facilities in North America.
Its third quarter results were strong, and the company recently sold its Bahamas facilities for US$258 million. The company does not pay a regular dividend, but “management has a track record of returning capital to investors via large special distributions and we believe that this will be the route they take with the proceeds from this sale.”
In fact, it did just that shortly after this report was written (and before it arrived on our doorstep), announcing an extraordinary dividend of $0.50 a share payable to shareholders as of December 14.
The Bahamas sale may cut into earnings, says the advisory, but “management’s short-term outlook is strong and given the current valuation, we continue to like this company going forward.” It’s a buy. The shares are up almost $1.50 since this report went to press, at $17.35.
Worth waiting for
There are five more energy service stocks that may be worth waiting for, the advisory informs us, although none are buys right now.
Akita Drilling (TSX-AKT.A) impresses with its strong balance sheet. It will still take a while for the drills to get back to peak activity, but this is “an interesting company for an investor with a long-term horizon.” It trades at $9.60 and yields almost 3 per cent on a dividend of $0.28.
The advisory is closely watching Hyduke Energy Services (TSX-HYD), which makes specialized equipment for the industry. It has not had a good year, but it has signed a big contract in Mexico and should be profitable again in the fourth quarter of 2009. It trades at just 25 per cent of book value at $0.33, but it’s not a buy yet. There’s no dividend.
There are several good points about Flint Energy Services (TSX-FES). It’s a well-known firm with a large repertoire of services and good connections in the oil sands. The stock is trading at good valuations, and activity should pick up in 2010. It trades at $9.70 with no dividend.
Badger Income Fund (TSX-BAD.UN) serves more than just the oil and gas industry. Its HydroVac Excavators are put to work for utilities, transportation, industrial and engineering clients as well as energy firms. Management’s outlook is neutral, but the units do yield almost 9 per cent on a distribution of $1.26. The units stand at $14.20.
Lastly, the researchers turns to two of their former buys, Phoenix Technology Income Fund (TSX-PHX.UN) and Wenzel Downhole Tools (TSX-WZL). Both have felt the impact of lower drilling activity over the past year, but both also invest heavily in research and development. The advisory believes both will “thrive nicely when the drilling market turns around.” Phoenix trades at $8.30 and yields 5.8 per cent on its $0.48 distribution. Wenzel trades at $1.06 with no dividend.
Buying energy service stocks now may seem like putting a lump of coal in your Christmas stocking. But by the time next Christmas rolls around, patient investors may find a few gushers springing up.
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