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Riding The Cycle With Weatherford

By Stephen Simpson

Tickers in this Article: CAM, RIG, NBR, PTR, COP, PBR, BHI, NOV, OIH, WFT

Hedge fund managers are a fickle lot. In their feverish quest for 2-and-20 (that is, a 2% base fee and a 20% performance-based incentive fee), hedgehogs are quick to chase the latest hot sector and just as quick to bail when they notice their peers furtively eying the exits. And so it has been for the energy sector this year; once the darling of the market (and seemingly the only way to make money in stocks), energy stocks have taken some hard lumps.

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When you look at the ETFs like Oil Services HOLDRs (NYSE:OIH) and SPDR S&P Oil & Gas Exploration and Production (NYSE:XOP), you see the pain. When you look at some individual service stocks like National Oilwell Varco (NYSE:NOV), Baker Hughes (NYSE:BHI), Smith International (NYSE:SII) and Weatherford (NYSE:WFT), you see a lot of pain.

Fair Weather for Weatherford
People who've followed the markets for a while probably won't be shocked to learn that Weatherford's recent stock performance masks what was a pretty solid operating quarter. Of course, the market is a forward-looking mechanism, and Weatherford's third quarter results were generated in an environment where oil started off in the $140s and stayed consistently above $90 a barrel.

Nevertheless, revenue was up 29% for the quarter, with solid performance in all of the company's geographic areas. Perhaps counterintuitively, I was most impressed by the segment that grew the least - the North American segment (about 46% of total revenue) grew only 19% this quarter, but nicely ahead of the 13% growth in rig counts.

Elsewhere, operating income grew in line with overall sales growth. Given the cost pressures that many service companies have been seeing since about 2005, that's a nice little detail.

Storms On the Horizon
How does the world look with oil stuttering around $70 a barrel? Well, my research and contacts suggest that operators are a little nervous. It's not so much that companies have a hard time making money at $70 a barrel (many companies have production costs in the $20 per barrel range). The issue is the huge costs of developing new fields - companies like Petrobras (NYSE:PBR), ConocoPhillips (NYSE:COP), Gazprom and Petrochina (NYSE:PTR) are looking at price tags in the tens of billions (and sometimes hundreds of billions) of dollars, and today's combination of falling energy prices and frozen credit markets makes that a daunting prospect.

Weatherford's Passport to Profit
Still, companies continue to develop new properties and drill wells and that's what's going to see Weatherford through this rough patch. I'm a little nervous about how drilling activity will play out in North America - as, I suspect, are operators like Nabors (NYSE:NBR) and Patterson-UTI (Nasdaq:PTEN) - but Weatherford management is confident about delivering solid growth next year from overseas markets. Moreover, for all of the dips and slowdowns in North American activity, nobody is seriously talking about less drilling and less development - after all, hardly anybody outside of the geology community was talking about the Bakken Shale Formation a few years ago.

A Rare Price, Replete With Risks
Weatherford is trading at valuations that I've come to associate with typical trough levels in quality service companies. Given that I see the energy market perhaps dipping over the next 18 months, but not crashing, that seems like an appealing set-up for an investment. My personal investing preferences run more to the deepwater operators like Transocean (NYSE:RIG) and the equipment makes like Cameron (NYSE:CAM) and National Oilwell Varco, but Weatherford is also high up on my watch list these days.

To learn more about this sector, check out our Oil And Gas Industry Primer.

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

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