This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers.We all know what has happened to oil prices. Fears of global shortages that drove prices up to near the $150-a-barrel level have subsided, and oil prices have since fallen by about a third. The oil-service stocks that had such a dramatic price run-up have declined right along with the base cost of energy. Since July of this year, the Oil Services HOLDRs ( OIH) has fallen in price from over $220 down to about the $160 level. I am a bottoms-up investor and don't usually take notice of a particular industry until it becomes extremely overvalued or undervalued. Right now, when I run screens for low-valuation stocks, many of the oil services and drilling companies are popping up. I believe this represents an opportunity for traders and investors alike. Although worldwide demand has slowed in recent months, I believe this decline is temporary. The current global economic situation may dampen demand in the short run, but eventually it will recover and continue to grow. In spite of all the election-year posturing about developing new energy sources, the truth is that petroleum will remain the world's major fuel source. Emerging markets will continue to grow, and their demand will increase in the long run.
In spite of the weakness in oil prices, we are seeing global demand remain firm for drilling and other services. The Mexican state oil company Pemex has been increasing its activity as its older oil fields begin to decline. Petrobas ( PBR) in Brazil recently made one of the largest oil and gas finds in decades and is looking to lock up long-term drilling contracts to exploit the discovery. Across the board, both international and domestic oil companies are raising their oil-services budgets to meet expected worldwide demand growth. Budgets for exploration and development are expected to grow by 20% in 2008 and 10% in 2009, according to industry analysts. This bodes well for the companies in the oil service industries. The potential for increased drilling offshore in the U.S. could be an additional source of long-term growth of the industry as well. Although the ban is being allowed to expire, it is seen by many as a political move, and most expect the subject to be revisited by the new administration. Should "Drill, drill, drill" become actual policy, the long-term future of these stocks is enhanced even further. Many of the stocks are cheap. I wrote about Bronco Drilling ( BRNC) last week. It remains one of my favorite stocks in the group. Shares of the land driller Nabors Industries ( NBR) have fallen 50% from the highs and have a P/E of just 8. The company is one of the largest providers of rigs in land-based shale drilling in the U.S. as well as Canada. Higher natural gas prices and new technology have spurred demand for this type of drilling, and Nabors will be a major beneficiary of this trend. Rowan ( RDC) is another stock with excellent prospects that has seen its share price plummet. In spite of record earnings, Rowan shares have fallen from over $47 to near $32 today. The stock trades at just 7 times earnings. The firm has recently been the target of a leading activist, Steel Partners. Rowan settled with Steel by agreeing to sell the LeTornueau manufacturing division and to buy back as much as $400 million in stock. It currently has bids from 30 interested parties and should get $1.5 billion for the division. These moves, combined with growing demand for its jack-up rigs, bode well for Rowan's stock price.
Offshore driller Enseco International ( ESV) is another stock I like in the group. Shares trade at a P/E of just 7 in spite of a growing backlog of international drilling contracts. The company is active in South America and could be a major beneficiary of new drilling off the coast of Brazil in the years ahead. Oil service stocks, particularly drillers, have come under huge selling pressure in recent months. Funds that specialize in momentum and commodity-oriented investment strategies have dumped them en masse as oil prices came down. Now we are starting to see value investors and mean-reversion traders begin to accumulate the shares. The stocks could be volatile in the short term, particularly with all the posturing currently going on inside the Beltway, but these shares are worth accumulating at these levels.
This was originally published on RealMoney on Sept. 29, 2008. For more information about subscribing to RealMoney, please click here.