The Rub in Parker Drilling's Promise

There are better ways to play the oil drillers.
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We are always on the lookout for companies with pricing power. This process usually turns up a handful of retail names, but the energy patch is showing some pricing power of its own, thanks to near-record oil and rising natural-gas prices.

Given that strength, at first glance

Parker Drilling

(PKD) - Get Report

looks like a promising name. The company provides drilling services on land and offshore -- including drilling rigs, project management and rental tools -- to the energy industry, and is benefiting from the tight supply in drilling rigs. In addition, drillers' increased activity is helping Parker's rental business, which lends tools to oil and natural-gas drilling companies through its subsidiary, Quail Tools. As of Dec. 31, 2005, Parker Drilling's rig fleet consisted of 23 barge drilling rigs and 24 land rigs. Most of the company's offshore drilling projects are focused on coastal waters.

Year-over-year revenue growth also provides evidence of Parker Drilling's strong operating environment. In its fourth-quarter earnings results, released Feb. 15, the company delivered revenue of $149.6 million and net income of $56.7 million, or 58 cents a share. This compares with revenue of $109.8 million and a net loss of $5.3 million, or 6 cents a share, in the year-ago period.

That 37% spike in revenue can be attributed to climbing day rates, the rates drillers charge to rent a rig and its crew for a day. These rates have helped the entire industry, and the Oil Service Index, which is the benchmark for oil service stocks, is up about 60% over the past 12 months.

Shares of Parker Drilling leaped 12% on the earnings report, but pulled back over the following weeks. We believe that decline may have been due to a lack of near-term catalysts for higher earnings growth, and we recommend that investors find better ways to play the group -- even though resurgent oil prices have helped push Parker Drilling's shares up. The stock closed Monday at $8.94. The company will report first-quarter earnings May 3.

In addition, the company is diluting shareholders with stock offerings, which will make earnings growth even more difficult in 2006. On Jan. 18, Parker Drilling announced a secondary stock offering to raise about $100 million through the sale of 8.9 million shares to the public. This took Parker's share count up to 107.9 million, making the deal about 9% dilutive to current holders of the stock.

The company plans to use half of the proceeds to invest in its rental business, construct two new land rigs, and build one new deep-drilling barge rig for use in the Gulf of Mexico. While this plan appears to have long-term benefits, Parker may not see the full effects from these projects until 2008, at which time the rig-supply shortage may be a thing of the past. So the return on these investments has a good chance of coming in materially lower than if the rigs were available today.

Also, while the company is spending shareholder money on new rigs, management sold seven land rigs in Columbia and Peru to pay down existing debt to meet specific goals laid out by the CEO in 2005. Even after the sale of rigs and subsequent debt repurchases, Parker still has $380 million in long-term debt and just $78.2 million in cash. The company has successfully paid down about $200 million in debt since 2002, though its debt-to-total-capital ratio will still come in at roughly 60% following this further reduction. This is some three times higher than the industry average of 20%.

Additionally, Parker Drilling, which was founded in 1934, has been traded on the

New York Stock Exchange

since 1975. But in more than 70 years of operation, the company's market capitalization is a mere $965 million. One possible reason for such lack of recognition from the market over the years could be seen in the company's retained earnings of negative $208 million at the end of 2005, which is a sign that Parker has not been using its capital in an efficient manner.

Looking ahead, the road appears bumpy for Parker. When day rates eventually start coming down and demand for oil rigs subsides, the company's top and bottom lines will suffer. Parker also has exposure in the Gulf of Mexico, where operations are always vulnerable to severe weather. Hurricane damage could lead to huge repair costs, which Parker Drilling cannot afford, based on its poor financial position.

We continue to like the 12- to 24-month prospects for certain drillers, and maintain a small position in the Stocks Under $10 model portfolio in another low-priced drilling company. However, we're steering clear of Parker until we see stronger evidence that the company's strategies are paying off.

William Gabrielski is a research analyst 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. Gabrielski welcomes your feedback;

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