Two Buyout Targets in Oil Equipment

01/10/2011 1:00 pm EST


Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Refineries outfitter Dresser-Rand and deepwater specialist Dril-Quip could tempt larger rivals, writes Elliott Gue, editor of Personal Finance.  

Merger and acquisitions activity continues to heat up worldwide, and oil equipment industry is a fruitful hunting ground for buyout candidates.

Two of the most likely targets are Dresser-Rand (NYSE: DRC) and Dril-Quip (NYSE: DRQ).

Dresser Riding Shale Explosion
Dresser-Rand, a leader in the manufacture and after-market maintenance of compressors and turbines, generates about 90% of its revenue from the oil and gas infrastructure spending.

Operators use Dresser-Rand’s centrifugal compressors to reinject natural gas and carbon dioxide back into oil fields to maintain pressures and enhance production. Compressors also feature prominently in gas pipelines as well as liquefaction, refining and processing facilities. 

Elevated oil prices should support orders from oil and gas producers. The rapid development of more than a dozen unconventional plays has prompted US operators to build new pipelines and storage facilities, slowly rationalizing an increasingly outdated system. This construction boom should continue as the shale gas revolution rolls on.

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Dresser-Rand's chemicals business is in the midst of an uptrend. Output from liquids-rich gas plays such as the Eagle Ford Shale in south Texas have dramatically increased the supply of propane and ethane, natural gas liquids (NGLs) used as feedstock to produce ethylene, the base chemical in most plastics. These NGLs are a welcome alternative to naphtha, which is produced from crude oil; an abundance of these relatively inexpensive hydrocarbons gives US chemicals producers a considerable competitive advantage.

With a market capitalization of about $3 billion, Dresser-Rand would be just the right size for a larger equipment provider such as National Oilwell Varco (NYSE: NOV) or Cameron International (NYSE: CAM). Dresser-Rand is a buy up to 40. [Shares closed at $41.81 Friday—Editor.]

Dril-Quip Works Well Under Pressure
Dril-Quip manufactures a wide range of offshore drilling and production equipment that is significantly more complex than land-based technology and must be designed to withstand the rigors of unforgiving deepwater environments, where extremes of pressure and temperature are a constant challenge.

Dril-Quip’s story is simple: Deepwater drilling is among the fastest-growing segments of the energy business, and the company benefits directly from this uptick in activity and development. The Macondo spill and subsequent drilling moratorium imposed by the Obama Administration slowed activity in the Gulf of Mexico—for the time being. But drilling in key deepwater regions outside the US, including Brazil and West Africa, continues apace.

Despite the company’s compelling growth prospects, valuation is a bit of a concern. The stock trades at about 25 times 2011 earnings estimates, a substantial premium to shares of Cameron, which go for 18 times next year’s earnings.

Dril-Quip continues to add capacity, a sign that management expects business to remain robust.

With a market capitalization of $3 billion, Dril-Quip could become an acquisition target. [Shares closed at $74.23 Friday, for a 2011 price/earnings ratio of 23—Editor.]

[Gue recently recommended two more takeover targets. His colleague Roger Conrad is tracking three potential targets among utilities—Editor.]

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