Higher Natural Gas Prices Could Pump up Oil Services Demand
Don't look now, but the prolonged cold snap in the U.S. has pushed natural gas prices toward multi-year highs above $4/btu. At the same time, most of the domestic oil services stocks have slumped to multi-month lows. The combination could present a buying opportunity for the domestic oil service firms of Baker Hughes (NYSE: BHI), Weatherford (NYSE: WFT), and C&J Energy Services (NYSE: CJES)to name a few that are intriguing.
A major reason for recent weakness in the stocks has been less-than-robust capital expenditure plans by exploration firms to end the year. The general guidance for the fourth quarter wasn't overly robust, but the recent cold weather and reduction of natural gas inventories has pushed levels below prior years. The latest weekly report from EIA showed inventory levels 3% below the 5-year average levels. Also, the inventory number is already a substantial 7.2% below the levels of last year.
It is still too early to tell if a new trend is forming, but investors need to remember that abundant supplies in the ground don't ensure abundant reasons to spend the capital in order to get the resource out of the ground. These three stocks should benefit once spending does pick up, and higher natural gas prices will ensure this eventually occurs.
Of all the major oil service firms, Baker Hughes provides solid upside potential from a greater focus on domestic natural gas services. In the third quarter, Eastern Hemisphere revenue surged 20% compared to last year, mainly from growth in the Middle East and Asia Pacific. However, North American revenue only gained slightly over the last year, but for the first nine months revenue is actually down for the year.
The company would be hitting on all cylinders if North American revenue, which accounts for nearly 50% of all revenue, were contributing decent growth. The percentage has dropped nearly 200 basis points in the last year. More importantly, North America accounts for nearly three times the revenue of the next largest region, Middle East and Asia Pacific.
Weatherford trails considerably behind Baker Hughes with half the market valuation. Weatherford, though, has a business closer in size than the valuation would suggest. The company hopes to wrap up a tax issue that has hampered management's focus on operating efficiencies for more than a year.
While Weatherford is much more focused on international operations with 60% of revenue from outside North America, the stock is nonetheless situated to benefit from a rebound in domestic demand. As with Baker Hughes, North America is by far the largest region at over 40% of total revenue. The impact of slower domestic business can be clearly seen in the $128 million year-over-year decline in North American revenue while the company as a whole had a slight gain. Again, the growth in the Eastern Hemisphere was strong all around.
Domestic focused start-up
C&J Energy Services has always had impressive margins, but the domestic hydraulic fracturing services company went public right at the peak of the market. Considering the company obtains 100% of its revenues from the U.S., the results have been in a continual decline over the last two years. In fact, earnings declined from $3.46 in 2012 to lowly expectations of only $1.34 this year.
The one intriguing part about C&J Energy is that management has been aggressively expanding during the lean times of the last year. The company bought the wireline business of Casedhole in 2012 to provide geographic expansion into the Bakken and services expansion into the wireline business. Amazingly, the company is even adding a small amount of horsepower into the fracking business at the start of 2014. Other plans call for growing units in the other service lines of coiled tubing and wireline. At the recent energy conference, the CFO suggested that C&J Energy could add units into an oversupplied market due to the demand for its higher quality of work.
The fundamental backup for oil services demand in North America is picking up with natural gas inventories declining below 5-year averages and extremely cold weather in the U.S. The combination is beneficial to Baker Hughes, Weatherford, and C&J Energy Services that have been hurt by weak demand in the U.S. Combined with already strong international demand, 2014 could be a strong year for the domestic oil service stocks.
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The article Higher Natural Gas Prices Could Pump up Oil Services Demand originally appeared on Fool.com.
Mark Holder and Stone Fox Capital clients own shares of C&J Energy Services and Weatherford International Ltd.. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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