Editor's Note: This was originally sent to subscribers of TheStreet.com's Stocks Under $10 at 10:30 a.m. EST on March 22.
A lot of observers are saying that the easy money has already been made in oil and natural gas stocks. But we believe there is still plenty of room for upside in the stocks of the drillers that are contracted to locate and extract energy resources. That is why we are initiating a 600-share position in land-driller
( GW) with the stock trading at $6.71.
We owned this Stealth Stock for the model portfolio in the summer of 2004 and were able to book some double-digit gains as oil prices sky-rocketed. Given the recent spike in energy prices and a rising capital-spending outlook for the energy industry, we believe shares are once again poised to deliver solid returns over the next six to 12 months.
Grey Wolf benefits from higher day rates -- the amount drillers charge for use of their drilling equipment and labor. On Feb. 24, Grey Wolf announced solid fourth-quarter earnings results of 5 cents a share on revenue of $129 million. The top-line number was largely in line, while the EPS came in a penny ahead of analyst expectations.
More important than the company's sound top- and bottom-line results was management's upbeat tone on the earnings conference call. The company is continuing to see an increase in day rates, which should lead to improved profitability in 2005. Additionally, the company sees day-rate increases accelerating in the first quarter over fourth-quarter levels.
One of the keys to Grey Wolf's profitability is the current environment in the industry, which is at or near full capacity. In other words, the more rigs that are out in the field generating revenue and not collecting dust somewhere, the better the company's margins will be. In Grey Wolf's 10-K filed March 16, the company confirmed that the industry is operating at or near full capacity, and it sees very little excess rig capacity in the market that can quickly be mobilized.
The above scenario, in which demand for rigs is outstripping the available supply, creates a favorable pricing environment for Grey Wolf that analysts expect to drive 2005 EPS to about 31 cents a share on revenue of $580 million. Should the company hit these targets, it would represent a sixfold increase in EPS and a 36% increase in revenue vs. 2004 full-year results of $425 million and 5 cents a share.
While the bullish case for Grey Wolf is compelling, there is the potential for downside in the share price should energy prices trade lower in the coming months. That said, we believe the long-term supply/demand imbalance for oil and natural gas, coupled with increased capital budgets of the major oil and natural gas production companies, outweighs this risk and creates a compelling risk/reward scenario.
Catalysts that can drive the stock higher from here include higher day rates, better-than-expected earnings growth, continued demand for oil and natural gas drilling, and upgrades from the six analysts who currently have a hold or sell rating on the stock. (The other six analysts who cover Grey Wolf have buy recommendations on the stock.)
The "easy" money in energy may have been made already, but Grey Wolf remains under the radar, has an 8% short position in its stock and is firing on all cylinders.
William Gabrielski is a research associate at TheStreet.com and is accredited with a Series 7 license. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.
David Peltier is a research associate at TheStreet.com In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. They welcome your feedback and invite you to send your comments to