The trends in the Zacks Oil and Gas - Drilling industry suggest a likely bounce in activity levels during the second half of this year. Investor optimism over an improving demand outlook and the subsequent rally in commodities bode well for drilling contractors like Helmerich & Payne HP, Patterson-UTI Energy PTEN, Transocean RIG and Nabors Industries NBR.

Industry Overview

The Zacks Oil and Gas - Drilling industry consists of companies that provide rigs (or specialized vehicles) on a contractual basis to explore and develop oil and gas. These operators offer drilling rigs (both land-based/onshore and offshore), equipment, services and manpower to exploration and production companies worldwide. Drilling for hydrocarbons is a costly and technically difficult, the future of which primarily depends on contracting activity and the total number of available rigs at a given point of time, rather than the price of oil or gas. Within the industry, it's interesting to note that the volatility associated with offshore drilling companies is much higher than their onshore counterparts and their share prices are more correlated to the price of oil. Overall, the drilling stocks are among the most volatile in the entire equity market.

3 Trends Defining the Oil and Gas - Drilling Industry's Future

Increased Number of Rigs: Oil and natural gas prices have rebounded sharply, revisiting their multi-year highs due to rising demand and geopolitical tensions surrounding the Russian invasion of Ukraine. Consequently, drilling activity has been picking up in the United States, a region which most drillers are highly dependent on. As a matter of fact, rig count as of mid-May was 714 compared with 453 a year ago, in sync with the strength in commodity prices. The number of active units in Canada and the international markets has gained sharply too. The steady growth in rig count is an encouraging indicator of drilling activity.

Low Replenishment of Reserves Point to Drilling Requirement: One of the key positive arguments for drillers is the focus on reserve replacement rate. Over the past few years, the supermajors have struggled to replace all of the oil and gas they churn out, raising concerns about future production. In this context, Chevron’s 10-year reserve replacement ratio (RRR) of 100% indicates the inability to add proved reserves to the amount of oil and gas produced. This clearly calls for a calibrated approach in meeting reserve shortfalls in the long run. Consequently, a gradual improvement in drilling activity looks likely.

Dwindling Pool of Legacy, High-Margin Contracts: For most operators, order levels have remained depressed and day rates are trending just above cash costs despite the strong rebound in commodity prices. This has put increasing pressure on their revenue-generating capacity. Further, as the companies’ legacy, high-margin contracts wind down slowly, the drillers are faced with the prospect of a drop in backlog (and consequently, revenues), which is likely to accelerate over the next few quarters. This also leaves the drillers vulnerable to address their massive debt maturities and investment in newbuilds.

Zacks Industry Rank Indicates Positive Outlook

The Zacks Oil and Gas - Drilling industry is a 7-stock group within the broader Zacks Oil - Energy sector. It currently carries a Zacks Industry Rank #101, which places it in the top 40% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates upbeat near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the top 50% of the Zacks-ranked industries is a result of a conducive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are optimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2022 have improved 42.9% in the past year, the same for 2023 have risen 126.9% over the same timeframe.

Considering the encouraging dynamics of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Outperforms Sector & S&P 500

The Zacks Oil and Gas - Drilling industry has fared better than the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.

The industry has surged 50.3% over this period compared with the broader sector’s increase of 39.5%. Meanwhile, the S&P 500 has lost 3.7%.

One-Year Price Performance

Industry's Current Valuation

Since oil and gas drilling companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of non-cash expenses.

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), the industry is currently trading at 11.32X, lower than the S&P 500’s 12.38X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 4.09X.

Over the past five years, the industry has traded as high as 24.74X, as low as 7.28X, with a median of 11.23X, as the chart below shows.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)

4 Oil and Gas - Drilling Stocks to Keep an Eye On

Patterson-UTI Energy: Patterson-UTI Energy is one of the largest North American land drilling contractors, having a large, high-quality fleet of drilling rigs. The company’s technologically advanced Apex rigs are the key to its success. PTEN’s proprietary design makes the rigs move faster than the conventional rigs, and drill quicker and more efficiently. Patterson-UTI’s acquisition of Pioneer Energy Services has boosted its scale and geographic presence. Following the transaction closure, Patterson-UTI possesses 166 super-spec rigs in the United States, with nearly 50% outfitted with alternative power sources to minimize emissions. In addition, this takeover expands Patterson-UTI’s geographic reach to foreign markets with the addition of eight rigs in Colombia, where Pioneer has served for the past 14 years with a well-recognized operations staff and set-up.

The 2022 Zacks Consensus Estimate for this Houston, TX-based company indicates 96.9% earnings per share growth over 2021. PTEN currently carries a Zacks Rank #2 (Buy). The stock has gained 89.9% in a year.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: PTEN

Helmerich & Payne: Helmerich & Payne is engaged in the contract drilling of oil and gas wells in the United States & internationally. Its technologically advanced FlexRigs are much in demand. The company has already upgraded most of its drilling fleet with the latest technology. Besides, Helmerich & Payne boasts a strong balance sheet, carrying around $542 million in long-term debt, with a debt-to-capitalization of just 16.5% compared with many of its peers that are hugely burdened with debts, accounting for around 50% of their total capital structure. With available liquidity surpassing debt levels and a lack of significant near-term maturities, Helmerich & Payne should sail through any difficult operating environment.

The fiscal 2022 Zacks Consensus Estimate for this Tulsa, OK-based company indicates 80% earnings per share growth over fiscal 2021. The provider of land and offshore rigs carries a Zacks Rank of 2 and its shares are up 65.1% in a year.

Price and Consensus: HP

Nabors Industries: Nabors is one of the largest land-drilling contractors in the world, conducting oil, gas and geothermal land-drilling operations. NBR is well positioned with a sound mix of high-performance rigs and new rigs working in key shale plays like Bakken and Permian. Nabors’ initiatives to expand its geographic reach and diversify its operating assets beyond land rigs bode well for its Rig Technologies and Drilling Solutions segments. Tesco Corporation, Robotic Drilling Systems and PetroMar's buyout have boosted the drilling operations and technology of Nabors, adding to the company's earnings and shareholder value.

The 2022 Zacks Consensus Estimate for this Hamilton, Bermuda-based company indicates 54.5% earnings per share growth over 2021. Nabors currently carries a Zacks Rank #3 (Hold). The stock has gained 38.2% in a year.

Price and Consensus: NBR

Transocean: Being the largest provider of offshore contract drilling services, Transocean's unrivaled backlog of $6.1 billion offers cash flow visibility. As it is, the company’s technologically advanced and versatile drilling fleet differentiates it from competitors and provides it with an edge. RIG reported revenue efficiency of an impressive 94.9% in the last reported quarter. This is an indication of minimal loss of revenues due to downtime and Transocean’s superior efficiency in translating its industry-leading backlog into cash. The company has also been taking necessary steps to enhance its fleet with modern and competitive rigs, while scraping off old and incompetent drill ships, which is expected to make its operations more technically effective and efficient.

The 2022 Zacks Consensus Estimate for this Switzerland-based rig supplier indicates 18.9% earnings per share growth over 2021. The #3 Ranked Transocean has gained 4.5% in a year.

Price and Consensus: RIG

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