The Company Gaining Market Share During Tough Times

Bear markets are painful but necessary. They rid the market of the “irrational exuberance” that fuels asset bubbles and allows stock pickers to better separate the wheat from the chaff.

Bear markets can also take place in specific sectors, as is happening right now in the energy market.  Yet in such lean times, the best companies can actually turn headwinds into tailwinds. That’s exactly what’s happening at Helmerich & Payne, Inc. (NYSE: HP).

#-ad_banner-#H&P owns and operates one of the world’s largest fleets of drilling rigs (primarily land-based). The rigs are typically contracted out to exploration and production companies looking to extract oil and gas from various shale formations in the United States.

Like the rest of the sector, H&P is beginning to feel the effects of low energy prices. In its recent earnings report, the company saw a 1% decline in revenue to $883 million and 14% drop in net income to $150 million.

Underlying these declines were shrinking active rig counts and falling dayrates, the daily amount H&P can charge for the use of its rigs. There was also a huge drop in utilization, or the percentage of active rigs contracted out. In Q2, utilization was just 68%, compared with 89% for the previous quarter.

With the energy sector downturn likely far from over, H&P’s performance will probably deteriorate further in the coming quarters, analysts warn. Off 33% from pre-crash highs, the firm’s stock reflects the gloomy outlook.

But as dire as things may seem, investors needn’t fret about H&P’s future. The firm has weathered downturns before, and knows how to take advantage of tumultuous time. Thanks to savvy management and certain key competitive advantages, it emerged from the Great Recession of 2008 with greater market share.

Now, as then, the firm holds a crucial edge: it owns arguably the world’s most advanced rig fleet, consisting mainly of its high-tech FlexRig series, which was rolled out just over a decade ago.

FlexRig, now in its fifth generation, is highly popular for exploration and production because of exceptional mobility that slashes transportation time between drilling locations. Compared with competitors’ rigs, FlexRigs also provide greater drilling power (by generating more than 1,500 horsepower) and higher-precision computerized control systems.

Perhaps most importantly, they’re known for superior horizontal drilling capability. The U.S. energy revolution of the past decade has been mainly about drilling horizontally for oil and gas deposits that would be unreachable any other way.

For exploration and production firms, such features translate to optimal time- and cost-efficiency. So even in a steep downturn, H&P usually enjoys more resilient demand and higher dayrates than rivals.

For instance, H&P’s current average dayrate of $27,600 is roughly a 15% premium to the industry average. Also, thanks to its FlexRig fleet, the company’s business backlog has held relatively steady compared to its competitors. This stood at $3.9 billion in Q2, compared with $4.6 billion the prior quarter.

Considering the state of the market, some investors may look askance at H&P’s fiscal 2015 capital spending budget of $1.3 billion — the highest total in at least a decade. However, it’s a sign of the same recession-era savvy I mentioned earlier. Rather than simply reacting to market weakness with a defensive posture, management takes the longer view, prudently allocating resources so the firm can pounce on new business that emerges as conditions improve.

This year, investors can expect more spending on things like rig technology and safety systems; cost controls within the company; and the elimination of older equipment. Rig construction will continue, though at a slower pace. That’s because utilization rates have plummeted and H&P typically prefers to build new rigs when there’s an abundance of new contracts.

Unlike many other energy companies, H&P has ample cash for such endeavors. The company has more than $700 million in cash, thanks in part to a recently-issued 10-year senior unsecured bond.

Moody’s, a credit rating service, assigned the bond a solid A3 investment-grade rating with a stable outlook. The rating is based on H&P’s very low leverage, high-quality rig fleet and significant contract backlog. In a press release, Moody’s described H&P’s liquidity for the next 12 months as “very good” and said the firm should have the financial flexibility for a protracted downturn.

Good news for income seekers: Liquidity should be more than sufficient to cover dividends, currently $2.75 a share and good for a 3.9% yield. H&P has increased its payout nearly 14-fold since 2009, with further raises likely this year and next, despite oil’s recent crash.

Risks To Consider: Rivals are increasingly trying to develop rig technologies in the same class as H&Ps. The more successful these efforts are, the greater the competition H&P will face. Also, the energy sector is highly uncertain right now, with the potential for oil prices to revisit prior lows or plummet to new depths. This would markedly worsen H&P’s outlook.

Action To Take –> In a tumultuous sector where it can be hard to distinguish attractive values from falling knives, investors would do well to own a market leader like Helmerich & Payne. Analysts at Goldman Sachs just upgraded the stock to “buy” from “hold” with an $85 price target, implying 12% near-term upside.

Regardless, they correctly cite the best reason for long-term investors to buy H&P: the firm’s large inventory of high-tech rigs capable of more than 1,500 horsepower. Since H&P controls nearly half the market for this type of rig, it “should see the largest market share gains of any service company as drilling activity rebounds,” the Goldman analysts say.

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