A Low-Cost Chinese Oil Drilling Play

09/29/2009 10:56 am EST

Focus: STOCKS

Robert Hsu

Editor, China Strategy and Asia Edge

Robert Hsu, editor of China Strategy, likes a Chinese manufacturer of low-cost oil drilling equipment.

Like many Chinese companies, [drilling equipment provider] WSP Holdings (NYSE: WH) benefits from low manufacturing costs and corporate overhead. So, with a low cost structure, WSP is able to produce the same quality products at least 30% cheaper than its foreign competitors.
 
WSP has a strong R&D team and state-of-the-art facilities. So, the company differentiates itself from most competitors by emphasizing proprietary technology research and new product development. One area [where] WSP really stands out is that it can respond to market demand quickly. 

These competitive advantages, coupled with superior management, have enabled WSP to build a globally recognized brand name in its industry. It has established a strong business relationship with China's Big Four petroleum companies, and WSP is one of the top two oil country tubular goods (OCTG) providers to PetroChina (NYSE: PTR) and China Petroleum & Chemical (Sinopec) (NYSE: SNP).

Although overall demand for oil drilling equipment contracted when oil prices declined sharply last year, there is still strong domestic Chinese demand for WSP's drilling products. Sales to China will probably continue to account for the majority of WSP's revenues for 2009.

WSP [also] recently gained significant market share in the Middle East and Africa. This is great news for the company, considering that oil prices are stabilizing and worldwide oil exploration and drilling have begun to pick up. So, new orders from overseas have started to kick in, and they should be reflected in WSP's fourth-quarter financial report.

In addition, WSP has also been focusing more on developing customer-designed, non-API products, which have significantly higher profit margin than products that are developed based on American Petroleum Institute standards. According to senior management, WSP's technology-intensive non-API products are going to the main driver of growth in the near future.

WSP [also] has been increasing its production capacity. As of July 2009, it has an annual production capacity of 924,000 metric tons with 13 threading lines and two drill pipe production lines. To increase production, the company has started to build new manufacturing and sales facilities in Xinjiang Autonomous region, as well as new production lines in Houston, Texas, in order to fill its North American market orders.

Given these new production line, the company is expecting production capacity to reach 1,344,000 metric tons by the first half of 2010.

Also, its recent acquisitions allow 70% to 80% of its steel requirement to be sourced in house. Such capacity expansion and vertical integration position WSP nicely for a rebound in the worldwide oil and gas industry.

WSP's stock also has an attractive valuation compared to industry peers and favorable dividend policy. And with the company's business set to pick up by year-end, now is a good time to start buying WSP on dips. So, I recommend that you buy WH under $4.50. (This small-cap stock closed slightly below $5.00 Monday—Editor.)

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