Goldman Sachs recently issued a note to clients, identifying what it believed are the 40 most undervalued stocks in this current market.
In my opinion, three of the most appealing stocks on this list are in the generally undervalued oil and gas drilling and exploration sector.
Sector growth
Oil and gas drilling and exploration services will always be in demand. As of October 2012, there were 197 offshore rigs under construction, a 16.5% expansion to the existing fleet. This is an example of the huge demand in the industry, and Goldman expects day rates for high-spec ultra-deep-water drilling rigs and ships to continue rising without any let-up in the medium term.
This is also good news for the world’s second-largest offshore drilling company ENSCO PLC (NYSE:ESV), which is also considered by Goldman to be undervalued. The market for offshore drilling is expected to grow at a compounded-annual-rate of 10.6% until 2018, from the current value of $73.1 billion to $121.1 billion, and ENSCO PLC (NYSE:ESV) should be at the forefront of this, considering the company’s dominance over the industry.
Backlogs show strength
The order backlogs for all three companies show the strength of the market and demand for products. At the end of Q2, National-Oilwell Varco, Inc. (NYSE:NOV)’s order backlog for equipment was at a record level of $13.95 billion, up 8% from the end of Q1, and up 24% from the end of Q2 2012. New orders during the quarter were $3.15 billion, reflecting continued strong demand for oilfield equipment.
Elsewhere, Cameron International Corporation (NYSE:CAM)’s backlog at the end of Q2 was $10.5 billion, its highest historical level. This was up from the prior year level of $7.5 billion, and the beginning of the year level of $8.6 billion. ENSCO PLC (NYSE:ESV) had a backlog of $11 billion, or two-and-a-half years of revenue guaranteed at 2012 levels.
Not only do these record backlogs show record strength in the market, but they also mean that these companies have revenue for the period, and investors are able to rest easy, knowing that money is going to continue flowing in. Indeed, ENSCO PLC (NYSE:ESV)’s backlog is worth two-and-a-half years of revenue at current rates, National-Oilwell Varco, Inc. (NYSE:NOV)’s backlog is worth three-quarters of revenue at current rates, and Cameron International Corporation (NYSE:CAM)’s backlog locks in a year-and-a-half at current rates. With revenues to some extent guaranteed for the next year or so, these companies should be trading at much higher valuations.
Valuations look attractive
In particular, all three companies offer growth at a reasonable price. National-Oilwell Varco, Inc. (NYSE:NOV) trades at a PEG ratio of 1.1, Cameron International Corporation (NYSE:CAM) trades at a PEG ratio of 0.96, and ENSCO PLC (NYSE:ESV) trades at a PEG of 0.6.
Valuations are below average
| VALUATION | ESV | Industry Average | CAM | NOV |
| Price/Earnings | 11.1 | 19.6 | 20.1 | 13.4 |
| Price/Cash Flow | 7.8 | 10.3 | 15.5 | 10.8 |
| Price/Sales | 3.2 | 0.4 | 1.7 | 1.3 |
| Price/Book | 1.3 | 3.1 | 2.6 | 1.5 |
| Return On Assets | 6.9 | 7.9 | 8 | 7.9% |
| Operating Margin | 36.4% | 17.7% | 12.5% | 17.7% |
As shown above, all three companies trade at valuations below the industry average. That said, Cameron International Corporation (NYSE:CAM) trades at a slightly higher earnings multiple, but I believe this is justified based on the company’s order backlog and revenue clarity for the next few years.
Having said that, all three companies trade at price-to-sales ratios higher than the industry average, which I believe is warranted. Still, as a world leader in the oil equipment market, National Oilwell should trade at a higher price-to-earnings multiple than the rest of the industry, and Ensco’s profit margin deserves a higher valuation on a price-to-free-cash flow basis, as the company’s operating margin is more than double the industry average.
I have covered National Oilwells and Cameron’s value more here. These three companies all offer stunning value in a generally undervalued sector. Oil is general considered to be a defensive sector, and there is no reason why oil service companies cannot be considered to offer the same defensive nature. National-Oilwell Varco, Inc. (NYSE:NOV) controls 60% of the global market for drilling equipment, and its low valuation does not justify its market dominance. In addition, Cameron is a world leader in the manufacture of high tech sub-sea blow-out preventing systems as well as land-based oil infrastructure related equipment, so demand for the companies services is unlikely to fall any time soon.Elsewhere, ENSCO PLC (NYSE:ESV)’s market-leading position means that the company’s drilling services will be required for many years to come, and the company offers investors a 3.5% dividend yield while they wait.
The article These Three Oil Service Companies Offer Stunning Value originally appeared on Fool.com and is written by Rupert Hargreaves.
Fool contributor Rupert Hargreaves owns shares of National Oilwell Varco (NYSE:NOV). The Motley Fool recommends National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco.
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