The Secret to Getting Texas Rich

Transcription

1 The Secret to Getting Texas Rich

2 MATT BADIALI S Real Wealth Strategist The Secret to Getting Texas Rich W E are poised for a rebound On March 22, 2017, John Paisie, executive vice president of oil industry research firm Stratas Advisors, spoke these words to a collection of U.S. oil industry executives at the Midland Country Club in Midland, Texas. The price of West Texas crude (WTI) began climbing three months later. The seeds of that rally began in 2016 You see, in 2016, oil inventories sat 400 million barrels higher than their five-year average. It was a major glut. High production, along with reduced demand, combined to push oil prices to 13-year lows. That got the attention of the Organization of the Petroleum Exporting Countries (OPEC). Revenues from oil fuel the economies of nearly all the member nations. Low oil prices hurt, but the plan they came up with hurt even more. OPEC forced its member nations and some key allies into cutting production for They agreed to a cut of 1.2 million barrels per day. That should have been enough to push crude oil prices higher. And it did crude rallied from around $27 per barrel in January 2016 to a sustained price around $50 per barrel for the latter half of 2016 and most of OPEC s production cut, combined with the toll low prices took on companies around the world, worked. Oil inventories around the world plunged. Today, according to the Energy Information Administration (EIA), oil inventories are now 1 million barrels below the five-year average. That means oil supply and demand are back in balance just in time for world affairs to have a huge impact on the oil market. Is Oil Heading to $100 a Barrel? Oil is a cyclical commodity. That means prices rise and fall over time. You might remember when oil prices plunged to the teens back in the 1990s, then soared to over $140 per barrel in After that, they plummeted into the mid-$20 range as recently as To see what I mean, take a look at the chart below: 1

3 The red arrows denote price cycles. They last as briefly as two years, but they can go as long as seven years. The table below puts these cycles into a more interesting perspective: The Cyclical Nature of Oil Price Cycle Periods Duration Rise Fall June 1990 to December years 142% -65% December 1993 to December years 88% -59% December 1998 to November years 231% -50% November 2001 to January years 332% -33% January 2007 to February years 184% -77% February 2009 to February years 235% -76% As you can see, oil prices can rise and fall rapidly. For example, from January 2007 to February 2009, the price went from about $51 per barrel to $145 per barrel on the way up. It then fell to about $34 per barrel, hence the moves indicated in the table: up 184% and then down 77%. I don t expect prices to plummet back to $27 per barrel anytime soon. In fact, it would be tough to think the oil price would even get close to $50 per barrel again. However, we can expect prices to bounce a bit as they go up from here. We can expect any fall in price to be brief. We ll use the brief falls as buying opportunities. I expect to see the price hit $100 per barrel before the end of 2019 on some big news. It could be war, political wrangling, natural disaster or rising demand. Something will put it up over the top. 2

4 The Permian Basin U.S. Shale s Moneymaker The Permian Basin is a huge geologic structure that sits under West Texas and Southeastern New Mexico. It s a giant, 86,000-square-mile basin nearly a third of the size of the Lone Star State itself! with a ridge in the middle. It was historically a prolific oil-producing region. In 1921, the Santa Rita No. 1 well became the first commercial oil well in the area. It flowed for 70 years. From 1921 to 2012, conventional oil fields in the Permian Basin produced about 29 billion barrels of oil and 75 trillion cubic feet of natural gas. However, in 2012, when the industry moved to unconventional shale, the basin exploded with untapped resources. The Permian Basin is all that remains of a tropical ocean lost in geologic history. A warm, lively ecosystem once flourished in the huge basin. Over millions of years, the basin filled with layers of rich organic material. Those layers became shale deposits. Eventually, sediment buried the basin and covered the organic material. After millions of years of compaction and heating, it turned into oil and gas. The Permian Basin contains not one, but seven, shale units rich in oil. In 1995, the U.S. Geological Survey estimated that the basin holds over 100 billion barrels of oil. However, operators dispute that claim. The CEO of Pioneer Natural Resources has said he believes the Permian Basin could hold 75 billion barrels of oil. That would put this basin second only to Ghawar in Saudi Arabia on the list of the world s largest oil fields. The World s Second-Largest Oil Field The Delaware Basin comprises the western side of the Permian Basin. It s a nearly mile-deep bowl of shale layers roughly 4,800 feet thick. It contains nine discrete shale layers full of oil. The larger Midland Basin makes up the eastern side of the Permian basin. A central platform separates the two sub-basins. The Midland Basin is only about 2,800 feet thick. However, it contains 15 shale layers. That thickness is what makes the Permian Basin so special. You see, even our most prolific shales, like the Eagle Ford in East Texas, are only a few hundred feet thick at most. The Bakken Shale in North Dakota averages between 10 feet and 120 feet thick. A recent study showed that a group of just four of those layers of the Permian Basin the Wolfcamp Formation appear to hold 20 billion barrels of oil. That s nearly equal to seven years of oil production from the entire United States. 3

5 The Permian Basin will likely remain a major oil producer for another century at the least. That s what makes it the oceanfront real estate of the oil industry: It s expensive to lease ground there, which means it s hard to break in. As recently as February 2017, rental rates for land in the Permian Basin ran to $60,000 per acre. That s a 4,900% increase in just four years. Imagine if the value of your house went from $50,000 to $2.5 million between 2013 and That high cost of entry puts up a huge moat around the companies already working in the Permian. Outsiders either pay up or stay out. Oil production in the U.S. is up to 10.3 million barrels per day. That s over 13% higher than one year ago. The way to play this today isn t with a pure producer. That s because the oil is having trouble getting out of the Permian. Producers in the Permian Basin aren t collecting the true WTI price for their oil. They are getting less. That means they aren t benefitting from the rise in oil prices as we would expect. There just isn t enough pipeline capacity to move the oil from the Permian to the refiners and the ports in Houston. So instead of buying producers, we want to own the picks and shovels in the oil patch. The companies that do the hard work the companies that drill the wells, put the wellheads on and hook them up to the pipelines for production These are the drilling service companies. Today, there are over 800 rigs in the U.S. with more than half of those at work in the Permian. Rigs continue to move into the region. Over the past year, the rig count in the Permian has increased by 30%. Companies are drilling there. This is a great sign that the market warmed up. And it means earnings improvement for drilling companies this year. Oil Service Companies Are Still Too Cheap Even though 2016 was the bottom for oil prices, it wasn t the bottom for oil drillers and service companies. As you can see from this chart of the VanEck Vectors Oil Services ETF (NYSE: OIH), the market doesn t believe the oil rally matters to oil service stocks: 4

6 The price of OIH today is around half of its 2014 high. It s up just 28% from its low in That s odd, considering that the price of oil nearly tripled over the same period. OIH s price remains low because investors are most sensitive to what they just experienced and the collapse of the oil price created serious havoc in their portfolios. Investors remember the ugly fall, and they don t trust the recent rise in oil prices. That s OK. It means we have time to put together a solid portfolio of oil service stocks ahead of a busy summer in the oil industry. You see, the oil patch is in full rally mode. As oil prices go up, more drilling and more production happen. At $70 per barrel, even offshore oil is profitable. And I m not alone in my thinking. The fact is, the blue chips are already moving higher. Helmerich & Payne (NYSE: HP) is the premier U.S. land driller. Its shares are up substantially since late Take a look: Helmerich & Payne's Rise Sep-2017 Oct-2017 Nov-2017 Dec-2017 Jan-2018 Feb-2018 Mar-2018 Apr-2018 May-2018 U.S. oil production is ripping higher. According to the Energy Information Administration, rig counts are up in every region of the U.S. today. We don t need other bargain hunters to push up these stocks. It ll be earnings that bring us the big gains. Schlumberger and Halliburton, two giant oil service companies, beat estimates for the first quarter of And improved earnings are on the horizon. According to Bloomberg: Both companies [Halliburton and Schlumberger], though, gave their blessings to existing consensus forecasts 5

7 for the second quarter, which call for Halliburton to boost profits another 40 percent to 58 cents a share, while Schlumberger is expected to grow at about half that rate to 47 cents a share, according to analysts estimates compiled by Bloomberg. Baker Hughes, the No. 3 oil services provider by market capitalization is expected to boost profits another 60 percent in the second quarter as it continues to integrate with the oil & gas business of General Electric Co. The oil service sector is far too cheap. Oil prices are up around $65 to $70 per barrel. Higher oil prices will spur more drilling, which will drive more demand for service companies. But the service companies prices don t reflect that. They are trading far too low. It won t last. Especially as earnings continue to climb. How Do We Know Oil Service Is Cheap Today? The simplest way to evaluate oil service companies is price-to-book value. That s comparing today s price to the cost of its drill rigs and equipment. Most of these companies are just big iron: drill rigs, drilling rods, pump trucks, etc. When the market hates oil services, you can buy that iron for less than book value, or the value of the asset. The average price-to-book value, since 2000, is about 2.1 times book value. In other words, the average price is $2.10 per dollar spent on big iron. Today, the market hates big iron. Look at the chart to the right. As you can see, the index fell by more than half from 2014 to 2016, recovered a bit, and then collapsed again in Most investors look at this and go back to tech stocks! But to me, this looks like a big ol pile of money just sitting there. We can buy the whole group for just 1.3 times book value, or $1.30 per dollar spent. That s skewed a bit by companies like Weatherford International and Halliburton. Those companies trade at much higher valuations today 3.0 and 5.5, respectively. However, some companies are incredibly cheap. For example, you can buy offshore drilling contractor Ensco (NYSE: ESV) for 0.28 times book value. That s 28 cents on the dollar for its giant drill ships. Helix Energy Solutions (NYSE: HLX), another offshore driller, trades for 0.7 times book value. These are companies that trade, on average, 1.7 times, 2.0 times and 1.8 times book value. That means, to get back to the average, these companies share prices must go up 500%, 186% and 125%, respectively. That s the opportunity we have. And with oil prices soaring and the blue-chip service companies heading higher already, we have a tailwind. We have the chance to lock in triple-digit gains from a fantastic oil service stock. Here s how we re going to play it. Patterson-UTI Energy (Nasdaq: PTEN) Patterson-UTI Energy Inc. (Nasdaq: PTEN) is a $4.8 billion North American oil and gas service provider. Patterson s shares are still well off their 2014 highs. Oil Service Companies Trade at 20-Year Low Prices $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 SOURCE: Bloomberg 6

8 Take a look: Patterson is a pure play into America s enormous oil and gas potential. It has been adding to active drill rigs quarter over quarter and expects this trend to continue through the year. Instead of buying new high-tech rigs, it s upgrading older rigs. This is a cost-effective approach for adding value to its services. This strategy is already working well. All eight of its rigs receiving upgrades are under contract. Currently, 177 of its 295 rigs are running under contract. That leaves plenty of room for Patterson to grow its active rig count. Patterson is made up of three subsidiaries: Patterson-UTI Drilling, Patterson UTI Drilling Canada and Universal Pressure Pumping. The two drilling companies operate land-based drilling rigs in the U.S. and Western Canada. Universal Pressure Pumping specializes in hydraulic fracturing (fracking), cementing and reservoir enhancement services. These are the services that drove the shale revolution. That makes Patterson a fantastic company to own as oil prices increase. We have a good opportunity to get into Patterson s shares today. Its share price fell 20% in the first quarter of You can see what I mean in the table below. The first-quarter EBITDA (earnings before interest, taxes, depreciation and amortization) is half that of the second quarter Category Q1 Q2 Q3 Q4 Q1 Revenue (Millions) $305 $579 $685 $787 $809 EBITDA* (Millions) $56 $128 $164 $184 $185 Dividend Per Share $0.02 $0.02 $0.02 $0.02 $0.02 Total Debt (Millions) $599 $714 $743 $867 $1,119 Cash (Millions) $467 $40 $38 $43 $304 *Earnings before interest, taxes, depreciation and amortization; Data from Capital IQ 7

9 Other than that, the numbers look excellent. The company shows steady growth in revenue and earnings. The company reported poor earnings due to adverse weather. Prices are moving higher today but haven t recovered yet. On a price-to-book-value basis, the company trades for 0.96 times book value today. The average value since 2000 is 2.24 times book value. That means Patterson s share price needs to go up 133% just to get back to average. Patterson is a great company trading at a large discount. We re going to buy it as part of our move into oil services. Action to take: Buy Patterson-UTI Energy (Nasdaq: PTEN) up to $23.50 per share. Use a limit order. We will use a 25% trailing stop on Patterson. Good investing, Matt Badiali Editor, Real Wealth Strategist 8

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