Who doesn't want the opportunity to make 300%, 400%—even 500%—on stocks? "As an investor right now," says Matt Badiali, editor of the S&A Oil Report, "I think this is the best time you could possibly be buying your oil stocks." In this exclusive interview with The Energy Report, Matt reviews the last two decades of this highly cyclical commodity, explaining how you can capitalize on 20-year lows in oil service companies before the world economies stabilize.
[Editor’s Note: Please click here for Part 1 of this interview]
TER: Let's talk about some of those opportunities from an investor's point of view. What are some of the investment plays that our readers should be looking at?
MB: Well, as you know, oil is a very cyclical industry, and folks who capitalize when it's down do very well. I think that you have an opportunity to make 300%, 400% and 500% in those oil service stocks. They're so volatile that when you look at the 20-year history of these things, when oil has moved 50% to 60%, they'd move 150%. So, that's where I look.
I've found the companies that have been around for 20 years, where you can actually chart their moves, and I told my readers there are some keys to buying these companies. You could buy the index, which doesn't move quite as well as some of these companies, but you have a safety margin there that I like. But if you're looking at individual companies, my criteria are longevity—they have had to be around through several of these cycles, which proves that their management team understands the nature of the oil business. And they also have to have low debt.
So, I like a company that doesn't have a whole lot of debt, and I also like to look at their 10-year average operating income; that's an old Ben Graham and David Dodd technique. You look at three, four, or five years of average earnings, and then you look at the price of the company based on that rather than looking at last year's earnings. A lot of people are falling into this trap using that price-to-earnings ratio. They were using last year's earnings when the price of oil was over $100/barrel and this year's share price, thinking, "Oh man, these companies are really cheap." And the trap is that this year's earnings could very well be negative, as the price of oil drops to $30, $40, $50 a barrel. Some of these guys are closing up shop.
The mining industry went through that, as well. And the base metal companies, if you used last year's copper company's earnings and today's prices, they look really cheap. Then you look at how much it costs to operate some of these mines and these wells, and they're going to be shutting some of this stuff down. So you just can't do that.
So I use 10 years of average earnings, and I bought companies that were cheap compared to 10 years average earnings. There are probably 10—15 companies with over $400 million market caps today that meet my criteria. And I think they're going to pay off big for investors. I think the three that I recommended recently will probably make 150% on an average over the next 18 months.
TER: Can you share some of those names with us?
MB: Sure, I recommended three. The first one I recommended was Rowan Companies Inc. (NYSE: RDC, Stock Forum), which is a driller with some offshore rigs. They're the classic example of a company that has been around for many years. They were founded in 1954, they own services that they would call "drilling service in stream" and they also have some mining and forestry equipment.
They're a big company; their average market cap over the last four years was nearly $4 billion ($3.7 billion). Today, they're about $1.4 billion; so, they've come way down. They're selling right now at just half of their book value; so, basically, you're buying all of their offshore rigs and all of their drilling equipment at half the price.
It's a great opportunity for an investor. All we have to do is have the market value for that equipment—what it's actually worth—and we've doubled our money. That, to me, is an incredibly powerful statement. We haven't had these opportunities in 20 years.
The second company I recommended was BJ Services Company (NYSE: BJS, Stock Forum); they're just under $3 billion market value. The company was founded in 1872; so they've been around a long time and they are the premier fracturing company. Remember what I said about the natural gas—the unconventional gas shale? I said one of the two technologies was horizontal drilling and then there was the ability to fracture these rocks with high-pressure fluid. Well, B. J. Services is one of the best companies in that field and the technology is now a main staple of the oil and gas industry. It allows us to drill for oil and gas where we've never drilled before. It's necessary, and so that to me is an incredibly huge moat around B. J. Services; these guys are not going away.
They have low debt, they're very cheap and right now they're trading at less than book value. If you look at their 10-year average prices, we stand to make between 175% and 260% gains if they just hit their averages, if they just return to the mean.
These are the opportunities that are just mind boggling; I've been jumping up and down about this for weeks now. I just can't get over it. This isn't one of those things when I say, "If they just returned their average," and you reply, "Well, Matt, it could take years; it could take decades for them to return to the average." Right? That's the problem with some of these deep-value investments. "Wow, we'll make a lot of money if we're patient."
Trading oil is not quite day trading, but it's like attention deficit disorder value investing. You have this fantastic opportunity, and we don't have to wait that long—18 months, two years.
The third company I recommended was Parker Drilling Company (NYSE: PKD, Stock Forum). You know Parker has always been one of my favorite drilling companies. They were founded 70 years ago, and they were one of the first companies to switch from steam to diesel back in 1935. They're great; they went international in 1945. And drilling is really all they do; they rent drilling tools and they do some construction. The company's been through these cycles before, and it's so incredibly cheap.
And the book value is less than .4; so again, it's one of those companies that, if the market just valued their tools and equipment for what they're worth, we'll more than double our money. And the gains look to be between 300% and 400% if Parker just comes back to average.
So, I'm not shooting for the moon with these. I'm not telling you if oil gets back to $150/barrel, you're going to make 200%. I'm telling you that if this industry just comes back to its long-term average —half way up to the peak—you're going to make 200%. So, it only has to come up half way and you're going to make three or four times your money. This is the kind of opportunity that we have right now because of what happened. Because the oil price fell in conjunction with this massive market decline caused by the financial industry, you have 20-year lows. You know, people have forgotten about the oil industry and are looking for the next bubble somewhere else. But oil is energy; we can't do without it. It is the fundament of our way of life today.
TER: Matt, earlier you said that a lot of these are looking at 18 months to two years to see what you're calling the 'triple-digit gain.' What's the key leverage point that you're looking for to say, "Okay, here we go; now, these things are going to turn and take off?" What are you looking for?
MB: I think I'm looking for a lot of small things, and I'm starting to see the first signs happening. First, the 30-day report came out yesterday and the amount of oil in storage was less than what analysts predicted. So that tells me there was more demand than analysts expected. Now with this recent price spike from $35 to $50, the rumors were swirling all around that China was stockpiling, putting together a strategic oil reserve. I think we're going to see some more of that, where countries are a little worried about getting their fair share.
But I also want to see some economic recovery. As we said, oil is an international commodity, and the real consumption happens when the economies are working. Right now, the economies are not working—that's what is giving us the opportunity. I think if you wait until you see those signs, you're going to miss the big gains. You'll be buying the companies we just talked about at over one times book instead of at half book value. So, if you think about that, if you bought it at half and it goes to two, you made 300% or 400%.
TER: Right.
MB: If you buy at one and it goes to two, you've doubled your money. So I think that in 18 months we'll be firing on all cylinders; I think it's probably a much shorter term before we start seeing oil price recovery. I don't subscribe to this real "doom and gloom" outlook that oil's going to stay at $35/barrel indefinitely. These are the same folks that stood at the top of $140/barrel and pointed to $250/barrel.
If you do the math and oil or gasoline prices are at $10/gallon, ladies and gentleman, I'm officially a bicycle owner at that point. Economically, it's still a market and markets work. The best cure for high prices is high prices, and the best cure for low prices is low prices. So in the oil business, you can look at the last 20 years and you see a market that works.
Matt Badiali is the editor of the S&A Oil Report, a monthly investment advisory that focuses on natural resources—from small exploration outfits, to equipment companies, to the biggest commodity companies in the world. In Matt's own words, "as a geologist, I focus on all natural resources including silver, uranium, copper, natural gas, oil, water, and gold, just to name a few." He's also a regular contributor to Growth Stock Wire, a free pre-market briefing on the day's most profitable trading opportunities. Matt has real-world experience as a hydrologist, geologist, and a consultant to the oil industry and he holds a master's in geology from Florida Atlantic University.
For additional comments on Rowan Companies Inc. (NYSE:RDC), BJ Services Company (NYSE:BJS) and Parker Drilling Company (NYSE:PKD) from newsletter writers, money managers, and analysts, click on the respective links or visit The Energy Report.
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