Building Your Oilfield Services Portfolio -- Part 2

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In the first part of this pair of articles on the oilfield services sector, we concentrated on the four biggest and best-known members of the group. Those are the companies you hear most about and consequently are most likely to add to your portfolio when, as now appears to be the case, prices of crude -- and occasionally even natural gas -- are ascending.

But once you get to know some of the other service companies, their shares can prove lucrative if your timing is right. For instance -- and this is by way of example, not self-aggrandizement -- I once placed a "buy" rating on Galveston-based service-boat operator Hornbeck Offshore (NYS: HOS) at $3 a share, and I joyfully watched it levitate to $18 within six weeks. I'll take luck over skill any day, but it's clearly tough to stumble onto that sort of return with the larger companies. (If it surprises you to learn that that particular Hornbeck is now owned by its onetime competitor Tidewater (NYS: TDW) , I'll clarify the confusion momentarily.)

Experience tells me that the ideal way to get to know the service companies, especially the smaller ones, is simply to begin by noting the group's primary functions and then placing each company in the classification in which it fits best. For instance, while a steady stream of acquisitions has consolidated the group as recently as five years ago, I still use seven separate categories in researching the services sector.

Functional separations
Nevertheless, I still break the group into seven functional classifications:

  1. The conglomerates -- hardly small companies, since they include General Electric (NYS: GE) , with its expanding energy group.
  2. Equipment manufacturers -- including National Oilwell Varco (NYS: NOV) .
  3. The land drillers.
  4. The offshore drillers.
  5. The transportation companies.
  6. The smaller well service providers (you might think of them as mini-Halliburtons (NYS: HAL) ), such as Key Energy Services (NYS: KEG) .
  7. The purely offshore service providers, such as Oceaneering (NYS: OII) .

There's no magic in my particular set of classifications. You may arrive at other groupings that work better for your purposes. The key is simply one of ease of keeping track of companies performing similar functions and of noting when generally similar companies begin to deviate one from another from a valuation perspective. By following the companies in their appropriate groups, you're far more likely to notice value distortions while there's still time to benefit from them.

A trio of examples
For the sake of perspective, let's look quickly at a trio of companies that might be included in the classifications above. I initiated this article by potentially creating confusion by mentioning service-boat operator Hornbeck Offshore, which I then noted had been bought by New Orleans-based Tidewater. Why, then, does it continue to have its own New York Stock Exchange ticker? Truth be told, although companies don't spawn other versions of themselves, Hornbeck essentially did.

A number of years ago, Larry Hornbeck formed Hornbeck Offshore in Galveston. A public company, it bore the ticker symbol "NYSE: HOS" until it was sold to its larger rival Tidewater in 1996. A year later, Todd Hornbeck, who had worked for his father's company, formed a second Hornbeck Offshore, headquartered in Covington, La.

The newer company, which obviously fits in the transportation category, includes an upstream segment that supports deepwater and ultra-deepwater operations in the United States, Latin America, and the Middle East. Its downstream operation includes ocean-going tugs and tank barges that transport petroleum products in the United States. Analysts' mean target for the company's shares is approximately 30% above their current trading level.

These divers have come a long way
Houston-based Oceaneering is among the few offshore service providers. Formed as a diving company in 1964, the company has matured into a worldwide provider of engineered products and services used primarily in the oil and gas industry. At the same time, it also serves the defense and aerospace industries.

Oceaneering-manufactured undersea robots -- or remotely operated vehicles -- were vital elements in ultimately containing the BP oil spill in the Gulf of Mexico in 2010. As one BP spokesman said, "Without these vehicles it would be impossible to do any of the work we're doing at the wellhead." The company is involved in operations in approximately 67 locations in 21 countries.

Varco's on the grow
My Foolish colleague Rex Moore is clearly -- and for good reason -- a fan of National Oilwell Varco, a Houston-based leader in the design and manufacture of a variety of components and equipment used in oil and gas well drilling. The company continues to expand, increasing its net income to $532 million in its recent third quarter, 32% above the same quarter in 2010.

Shortly after the close of the quarter, the company completed the acquisition of Ameron International, a multinational manufacturer of highly engineered products and materials for the chemical, industrial, energy, and transportation markets. The completion of the merger closely followed an announcement by National Oilwell Varco that it has inked contracts to supply drilling-equipment packages for seven drillships to Estaleiro Atlantico Sul, a shipyard in northeast Brazil.

I could continue with further discussions of solid members of the services potion of the energy industry. But I think you get the picture: There are numerous solid, money-making opportunities within the group. Proper organization of your research can take you a long way in getting to know the smaller and more specialized services companies. I suggest you add Hornbeck Offshore, Oceaneering, and National Oilwell Varco -- along with other members of the sector that you find intriguing -- to your Motley Fool Watchlist.

Looking for more ideas? The Motley Fool has created a new special oil report titled "3 Stocks for $100 Oil," which you can download today, absolutely free. In this report, Fool analysts cover three outstanding oil companies. Get instant access to the names of the three oil stocks -- it's free.       

At the time this article was published The Motley Fool owns shares of National Oilwell Varco and Tidewater.Motley Fool newsletter serviceshave recommended buying shares of National Oilwell Varco and Oceaneering International. Try any of our Foolish newsletter servicesfree for 30 days.We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Fool contributorDavid Lee Smithdoesn't own shares of any of the companies named in this article. The Motley Fool has adisclosure policy.    

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