This column was originally published on RealMoney on July 29 at 2:00 p.m. EDT.
It was hard not to like what the contract land drillers had to say this week. Whether it was
Helmerich & Payne
( GW), the message was loud and clear: Demand for drilling rigs is near record highs and continues to get better.
Nearly every available land drilling rig is spoken for and companies with cold stacked, older rigs are scrambling to find ways to bring them to market quickly. With demand so strong and capacity at its limits, rig companies get pricing power.
The result was earnings that outpaced expectations and outlooks that should lead to a big boost in earnings estimates for the second half of 2005 and well into 2006. For example, Nabors reported earnings of 82 cents per share for the second quarter, 10 cents above the consensus estimate. The consensus for full-year 2005 was $3.38 per share and that will now likely move to around $3.70, a number the company said was achievable on Thursday's conference call. Yet if the drilling market continues to show the kind of growth it experienced in the first half of the year, it is not a stretch to think Nabors could earn nearly $4 this year and $5 in 2006.
The reason for such strong earnings growth rests both with utilization and, even more, with rig companies' pricing power. Margins -- the profit per rig per day -- almost keep pace with revenue growth, meaning that every day-rate increase translates into a meaningful boost in the bottom line. While labor costs will rise as more crews are needed to man the rigs, margin growth should remain robust in the second half of the year, growing in the range of $500-$1,000 per day in both the third and fourth quarters.
Not only is the U.S. and North America rig market continuing to show signs of acceleration, there are renewed signs that international demand for land rigs is also growing. Whether it's the Saudis looking for more rigs to quell the production declines in their maturing oil fields or new development in countries like Libya, companies such as Nabors say there will be demand for an additional 60-plus land rigs in the coming 12 to 24 months. Combined with its dominant position in the U.S. and Canada, Nabors is also the leading domestic company in international markets.
Many of the land rig companies are worth a look, as it appears demand will grow relatively unabated in the coming six months. To compare the land rig companies, investors should look at margins, margin growth over time and the number of rigs that are subject to "term" contracts -- meaning they will work at the same price for an extended period of time, vs. the majority of rigs that work on well-to-well contracts, meaning they have the opportunity to raise prices more often as rigs move to new jobs.
In addition, check out the balance sheets as the need for more rigs also means the need for more capital to refurbish old rigs or build new ones. And finally, take a peek at management, as seasoned managers have a much better feel for pricing and operations in a supply-constrained market.
Building for the Future
With rig supply tightening, rig companies are not only talking about bringing older rigs back to market, but also building new rigs. Nabors is looking at new builds and significant refurbishments to meet additional demand of up to 100 rigs they see over the next 24 months. Other contract rig companies are likely to experience demand growth.
That means more capital spending -- Nabors says it will expand its 2005 capital budget to more than $1 billion -- and that should benefit
National Oilwell Varco
The company is the combination of National Oilwell and Varco, which created a dominant player in rig construction and rig components. The merger -- completed earlier this year -- should provide additional operating synergies over time and the combined entity should remain the domestic and global leader in rig components and oilfield capital equipment.
While other companies -- such as
LeTourneau division and
-- are likely beneficiaries of rig capital equipment orders, by far the largest beneficiary is National Oilwell Varco.
Worldwide, National Oilwell Varco commands over 50% of the global rig construction and capital equipment market. In the first quarter, National Oilwell Varco reported a sequential increase of 9% in overall backlog, to $852 million. That backlog number continued to grow into the second quarter and is likely to continue to show steady growth as additional new-build and component orders are booked in the second half of 2005.
The strength of the backlog is becoming clear: Last year, average lead time for delivery of a new-build land rig was about four months; today, it is six to eight months at a minimum. On its earnings conference call, Grey Wolf said it was experiencing up to a year lead time for certain rig components.
As demand for components to refurbish existing rigs and new builds continues, backlog should grow and lead times should extend. That provides better visibility for earnings and growth over time.
Current consensus earnings estimates of $1.95 per share for the year seem secure and estimates for 2006 of $2.56 may be low, based on the current backlog trend, especially if additional demand provides National Oilwell Varco with additional pricing power.
Growing demand for rigs is certainly good for the land drillers; it may be even better for National Oilwell Varco.
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At time of publication, Edmonds was long Nabors, although holdings can change at any time.
Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he appreciates your feedback;
to send him an email.