– In an economic rebound with stable oil, HP stock could rise up to 60% long term.

– Indiscriminate energy rally, but it’s time to pick financially strong companies

– HP is tech savvy; has robust balance sheet; cutting expenses; should survive and thrive

Regular readers of the research on our website know that we’ve been focusing in recent weeks on the attractions of cyclical stocks.

The energy sector is up over 80% since the lows of March 23. But it’s also still down by over 40% from just 18 months ago. Granted oil prices were at $70 per barrel then, vs near $40 now.  Still, energy remains beaten up badly.

My view is that this energy bounce is the first wave, in which all stocks go up indiscriminately—even those in bad financial shape—because the sector is just less hated. The recent example of companies facing bankruptcy (Chesapeake Energy, CHK, among others) seeing their shares rise by large margin should tell you that.

The opportunity, I think, could be in the second wave of sector and stock improvement. It will be the best run companies in good financial shape that should do better. I think there’s gas left in the tank, if you’ll pardon the bad pun. A side benefit is diversification.  It’s possible many investors have bailed out of energy, perhaps completely.  If we are right, that the economy is recovering, then oil will be a necessary commodity and energy should be a necessary part of your portfolio, even if a small part.

The stock today is Helmerich & Payne (HP), a 100-year old land driller (US land drilling is 84% of revenue) that is poised to survive today’s tough times and thrive when good times return, argues Jake Dollarhide, who runs Longbow Asset Management in Tulsa, OK. (Both Longbow and Dollarhide own HP shares.)  The devastation in the oil patch has left many companies in the “have not” category, that is firms leveraged to the hilt in the pursuit of “drill baby drill” policy at all costs, he says. 

The “have” companies are stable and with strong enough balance sheets to withstand the tide of falling oil prices. Among drillers many investors might not know that HP has a strong balance sheet, perhaps the best among its peers, and is a technological leader.

HP has done the difficult things necessary to ride out the storm.  It has recently cut the dividend to $1.00 annually from $2.44, but still offers a robust 4% yield. HP had raised its dividend each year for nearly the past half century, showing how well it’s been run despite being in an “boom and bust” industry.  It is reducing administrative jobs.

HP’s debt-to-capitalization ratio is around 12% and net debt to cap around 2%, again among the lowest in the peer group, with no maturities until 2025, so that gives the driller some breathing room in these tough times.  (See chart below.)  HP has over $1 billion in liquidity, including $380 million in cash, and an investment grade rating (Baa1 by Moody’s), rare in the oil service industry.

Ironically, that the time to buy those companies that will survive the bad times like this and thrive in the better times ahead.  HP “isn’t coiled into a fetal position like many energy companies,” he says.

HP is opportunistic. It has a history of being a technological leader, using small “bolt on” acquisitions of other firms that help it stay ahead of the pack in drilling technology. In the last two years it acquired DrillScan, a leading provider of proprietary drilling engineering software, well engineering services and training for the oil and gas industry, and Angus Jamieson Consulting, a software-based training and consultancy. HP says it is widely recognized as an industry leader in wellbore positioning.

Years ago rigs just poked a hole in the ground; it was rudimentary. For example, two decades ago it invented Flexrig and is now up to the 5^th generation. HP’s Flexrig systems give it a premium margin when times are good.  There’s not enough space to fully explain it, but Flexrig is a HP trademarked specialized drilling rig with rails at the bottom and designed to drill multiple wells on a pad without the great expense of having to tear the rig apart and moving its pieces with a crane. It means HP can reconfigure its idle rigs quickly to meet producer demands and capture market share—when demand returns, of course. HP is unique, “the Tesla of drillers,” Dollarhide quips and it will continue to invest in technology, something the company prides itself on.

The second quarter ended March 30 saw a loss of $3.88 per share vs a profit of 27 cents in the first quarter, but the 2^nd was hurt by select one-time items. Absent these, the adjusted EPS was a loss of 1 cent vs an adjusted 13 cents in the first quarter. In the second quarter conference, the company said it will remain focused on establishing new commercial models, expanding digital technology offerings to customers, increasing its international presence and cost management. “Liquidity is critically important at a time like this, and we are actively reducing expenses in a thoughtful and intentional manner,” HP said.

At this point it’s difficult to rely on a price/earnings ratio in this industry because of its distress. My rough guide is that HP’s long-term median P/E is 20 times and I believe it could earn $2 per share in a return to US growth in a couple of years. (It earned $4.37 as recently as 2018.)  That could imply a $40 stock in a couple of years’ time, or a 60% rise.  Of course, much must go right for that to happen. 

The fiscal third quarter results will also not be pretty, but the stock’s rise from $14 to $25 is in anticipation of better times. Wall Street has begun to take notice, with, for example, both Bank of America and Credit Suisse raising their ratings on HP to Buy or Outperform in recent weeks. I think other analysts will join them in coming months.

HP has a leading market share, about 24% of the land fleet. Now, only a third of its 300 global rig fleet is contracted. That doesn’t sound particularly bullish unless you believe the economy is on the mend and the idled fleet could find work.

Where I could be wrong: Oil prices could crater again because we are too optimistic about the world economy and that would hurt the stock not only of HP but perhaps the entire market.  HP management could make a poor acquisition.

Bottom Line:  If, as I believe, the world economy is on the mend, then stable to rising oil prices should be good for this well-run driller with relatively low debt. I expect it to survive and thrive.

Prior “Signals”