Oil Thirst Favors This Hired Gun

03/07/2011 3:38 pm EST


Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Contract driller Patterson UTI has been riding the energy-exploration boom in the US, to an 87% increase in revenue last year and another 55% rise projected this year, writes Ian Wyatt of Ian Wyatt’s $100K Portfolio .

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Patterson UTI Energy (Nasdaq: PTEN) is a Texas-based company that drills onshore wells for other companies that are exploring for oil and natural gas.

Think of Patterson UTI as a hired gun. It gets paid a day rate for drilling services, whether its clients hit paydirt or not. This limits the company's exposure to the risk of drilling in the wrong place.

Patterson UTI, with a $4 billion market capitalization, owned 341 land-based drilling rigs at the end of 2010. This made the company the second-largest operator in the US. The company offers well drilling services in many of the most promising regions for domestic oil and gas production, including the Bakken Shale, The Marcellus Shale, and the Eagle Ford Shale.

This company benefits when demand for rigs outpaces supply, which results in higher rig-utilization rates and increased contract fees.

Rising Rates, Inflating Profits
With the price of crude oil rising, demand for land-based drilling is increasing. This is a big positive catalyst for Patterson UTI, which was able to raise its day rates by $1,360 in the fourth quarter of 2010, to $19,090 per rig. While rates charged to its clients increased 7.6%, operating costs per rig increased by only 3.1%. This led to profit expansion in the latest quarter.

Not only is Patterson UTI raising rates, but it's also adding more operating rigs. In the fourth quarter, the company increased its rig count by 9% compared with the third quarter. By the end of January, the total number of rigs in operation had grown to 204.

While higher rates have been a boon to Patterson UTI, the company also benefits from the stability offered by long-term contracts. During 2011, roughly 40% of the company's rigs will be under long-term contracts. While these contracts limit the upside opportunity from increased day rates, they do provide added security.

Fast Growth, Cheap Stock
Patterson UTI's growth has been downright impressive. In 2010, the company grew revenue by an astounding 87%, to $1.46 billion. The company that lost $38 million in 2009 turned around and delivered a profit of $117 million, or $0.72 per share, last year.

Growth in the current year is expected to be similarly impressive, with analysts calling for a 55% increase in revenue. They're even more bullish on earnings per share, calling for $1.79 in 2011. Analysts have increasingly been warming up to Patterson UTI, and in the last 90 days, earnings estimates have been revised up 30%—largely a result of a very strong fourth quarter and a bullish outlook by management.

With all of this growth and rising expectations, investors might expect Patterson UTI shares to command a healthy premium. In fact, they are a steal, trading at just 15 times earnings-per-share estimates for 2011. It's extremely rare to find a stock growing at such a rapid clip, yet trading at such a reasonable valuation. The stock trades well below industry peers and the Standard & Poor’s 500 index as a whole.

Given the company's room for continued growth in 2011 and 2012, I think a fair value for the stock today is $32, which translates into a price-to-earnings multiple of 18 times current-year earnings. The company also pays a small $0.20 dividend per share, providing a yield of 0.8%.

Buy Patterson UTI below $27. [Shares traded some 2% above that threshold Monday—Editor.]

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