Here's a look at what could be one of the best moneymaking stock groups in '81.
On Nov. 6, a secondary offering of Smith International shares -- 2 million of them at $50 each -- was offered to the investing public. The word is that Morgan Stanley & Co., the lead underwriter, had a tough time getting them all sold, and, in fact, had to swallow a couple of hundred thousand shares to keep the stock from taking a drubbing. At press time, a little over three weeks later, the stock of the drilling tool manufacturer had jumped to 66 1/4 -- a hefty short-term run-up of more than 32 percent.
About a week and a half before the Smith offering, Schlumberger sold 4.8 million of its 5.5 million shares of Rowan companies, an onshore and offshore driller, at 36 1/4. Too bad Schlumberger didn't wait a month. Today, the stock's around 45; that's nearly a 28 percent spurt.
These are graphic illustrations of the investor boom in oil service and equipment companies. The concept is simple enough: Surging energy prices -- plus fears of shortages -- have sparked a tremendous increase in oil and gas exploration. And just about any company that has any kind of product or service associated with the pursuit of energy is bound to benefit.
Clearly the chief beneficiary -- at least in the marketplace -- is the offshore driller. This is the company that provides those rigs that drill beneath the ocean floor. There are 450 to 500 rigs worldwide, ranging in price from a couple of million dollars to upwards of $70 million. And in just a little more than a year, daily rental rates -- reflecting mushrooming demand -- have shot up from $20,000 to $70,000, with $100,000-plus expected in the next couple of years. Drilling rigs are in extremely tight supply and virtually every new one coming on stream in the next 12-15 months already has been rented out for anywhere from two tofour years.
No wonder then that offshore drilling stocks have gone through the roof. From last January through mid-November, the stocks of offshore drillers (as measured in the Standard & Poor's index) have risen 156 percent; in the same period, the S&P 500-stock index is up 31 percent.
So what now for this red hot group?
For some thoughts, I chatted with Stephen Leeb, who puts out the twice-monthly market newsletter The Investment Strategist (of Jersey City, N.J.). The 34-year-old Leeb, an above-average stock-picker and the former research director of Indicator Digest (a leading investment advisory service), had recommended the offshore drillers back in January. So any of his subscribers (now numbering 1,600) who followed his advice must love him.
Despite the gigantic advances, Leeb's enthusiasm remains intact. He thinks a select group of them, nine all told, should outperform the market by at least 25 to 30 percent over the next 12-18 months. And within this period, he thinks, the nine have the potential to appreciate at least 50 percent. And one, Santa Fe International, his favorite, could double in price, he believes.
The other eight: Global Marine, Atwood Oceanics, Ocean Drilling, Reading & Bates, Rowan Companies, Sedco, Western of North America and Zapata.
In arguing his case, Leeb says the offshore drillers will probably turn in the single best earnings performance of any group in the market over the next three years. He figures his nine favorite companies, in this period 72 percent annual profit gain.
Granted, the stocks are sporting lofty price-earnings multiples -- a little over 22 times trailing 12-month earnings; that's more than double the current market indices. But Leeb says the average multiple is only about 10 if you're willing to look out to '82 earnings prospects. And that's what he think should be done.
One of the key questions you have to ask yourself in judging these stocks, considering their sharp run-ups, says Leeb, is the visibility of earnings growth beyond '82. And it's reasonable to assume growth rates of 25-35 percent a year between '82 and '85, in his opinion.
The reasoning: "We're just going to need more energy; the Middle East is not going to calm down, and higher oil prices mean greater incentives to drill."
Leeb sees a major plus in the Natural Gas Policy Act, which ensures that newly discovered domestic gas will double in price through the next five years. n
And the political icing on the cake, he adds, is the election of an administration that favors decontrol of energy prices -- as well as the opening of more federal lands for oil and gas exploration.
It all sounds terrific, but I reminded Leeb of the overcapacity disaster that struck the offshore drillers in the '75-'78 period following the buildup of rigs after the '73-'74 oil crisis. In that period of excess capacity, Global Marine ran in the red for a couple of years, while Santa Fe International and Reading & Bates were stung by sinking earnings.
Could it happen again?
"I believe the industry has learned its lesson," says Leeb. He notes that industry plans presently call for only 148 rigs to be added between now and '83 or an annual increase in capacity of around 10 percent. "No one's building like gangbusters," he says.
Leeb acknowledges that a major economic setback -- one that might depress oil prices -- would have a decidedly negative effect on the offshore drillers. But he says he doubts that's in the cards at this time.
The British government recently announced plans for a tax on North Sea oil output. And Santa Fe International, the company Leeb likes the most, took an instant drubbing in the marketplace, dropping nearly 4 points, because of its gas and oil holdings there.
Leeb, though, believes this will not seriously impair the company's earnings prospects. He's estimating $7.25 a share in '82, possibly even over $10 a share, vs. 78 cents a share in '79. He also points out that the company, through its engineering and constuction subsidiary (C. F. Braun), is in a strong position to grab a significant chunk of the synthetic fuel contracts.
Leeb, enthusiastic and not a tout, emphasizes that the offshore group is extremely volatile in the marketplace. And therefore, he says, investors have to be prepared for rapid short-term declines of 10 percent, and possibly more, in the event of a bad stock market.
"But if you want to play the game aggressively in a group that should continue to be one of the hottest over the next year and a half, the offshore drillers," he's convinced, "are the place to be."