Precision Drilling (PDS, Financial) provides energy services primarily to the North American oil and gas industry. Due to the carnage in oil prices, the stock has declined from a 2014 high of $14.54 to current levels of $5.17. The stock is currently trading at an EV/EBITDA of 3.97, price to sales of 0.75 and price to book of 0.68.
Due to the sharp decline in the stock in the last few months, all the valuation metrics seem attractive and might lure investors into considering exposure to the stock. However, in my view, Precision Drilling remains unattractive and investors need to avoid the stock until oil prices see some recovery.
The Baker Hughes (BHI) rig count data is showing a continuous fall in the rig count, and this is the first reason to be bearish on Precision Drilling. The decline in rig count is coming from lower oil prices and with oil touching new lows; it is entirely likely that the rig count will also continue to decline in the coming months.
The reason to believe that rig count will continue to decline sharply in the coming months is oil prices and the probability that oil will not surge any time soon. There is excess supply and global consumption is not increasing at a strong pace.
With a clear global economic slowdown, the consumption will remain weak and the supply-demand dynamics point to sustained lower oil prices. This is negative for Precision Drilling in the coming months and I expect the bearish momentum for the stock to continue.
Another negative point, that will impact the company’s revenue in the coming year, is the number of rigs that are in the spot market. Precision Drilling has 92 rigs that are contracted for 2015 out of the total 222 rigs.
The implication is that the remaining rigs are in the spot market (medium- or short-term contracts) that is likely to remain very depressed in 2015 due to lower oil prices translating into lower demand from oil and gas companies. Further, even if the rigs in the spot market are contracted, the day rates will be much lower than it was in 2014, and this will impact the company’s revenue and EBITDA margin.
In my view, if oil prices remain around $50 per barrel for the first six months of 2015, there will be many rigs that will be idle and this will be certainly be negative for the stock. Some oil and gas companies have already slashed their investment outlook for 2015 and there will be more investment cuts in the coming months. This will keep Precision Drilling sideways or lower.
Therefore, the onshore rig market looks very gloomy at this point of time and it would be best to avoid investing in onshore rig stocks. It is said that the best time to invest is when sentiments are the worst.
However, as oil prices are not recovering anytime soon, investors need not rush to buy value stocks. As Goldman Sachs forecasted today, oil can even fall to $40 per barrel. So the uncertainty remains and it is not a good idea to make a plunge in the sector amidst the uncertainty.
