It's far from being a household name, but Stock Advisor selection Unit Corp. (NYSE: UNT) is no stranger to many of our Motley Fool CAPS players. The Oklahoma-based energy company recently unseated Helix Energy Solutions (NYSE: HLX) as top dog in all of CAPS-dom. Yet in light of recent softness in the natural-gas market, such a distinction may appear highly improbable. Are CAPS dwellers rallying behind the wrong stock?
A first glance would make you wonder, because Unit's first-quarter earnings report does identify several recent challenges. Nasty weather and a Valero (NYSE: VLO) refinery fire hampered oil and gas production. Gas-price realizations were weak, and rig overcapacity pressured dayrates, which the company maintained at the expense of fleet utilization. The company made the best of this situation by opportunistically scheduling upgrade work on offline rigs.
But the impact from all of this news was really quite minimal. Cash flow from operations dropped less than 3%, after adjusting for changes in working capital, and well completions matched the company's five-year average. Despite the suboptimal operating environment, Unit has actually held up well, and three of its attributes lead me to believe that it will outperform its peers over the full cycle.
1. The corporate structure
Because Unit operates three distinct businesses, its asset base and cash flows are diversified. In addition to drilling, the company engages in the exploration and production of oil and gas, as well as midstream gas operations. The company's reserve-replacement record is outstanding, and those reserves in tandem with Unit's numerous prospective wells represent significant long-term value.
2. The fleet
The company is in the sweet spot when it comes to rig type -- 64% of its fleet falls in the range of 800 to 1,700 horsepower, the category least resistant to demand fluctuation. In management's experience -- which stretches back decades -- size does matter, but the biggest rigs aren't necessarily the best over the full cycle.
3. The customers
The shift in Unit's customer mix away from "checkbook" operators and toward larger customers such as Chesapeake Energy (NYSE: CHK) also translates to steadier demand and higher margins throughout the commodity cycle. Bigger players have the financial flexibility to maintain drilling programs in periods of weakness.
So despite some dicey appearances on the surface for Unit, I think our CAPS community is calling this one correctly. Although you could likely find a better entry price at some future moment of extreme pessimism, the shares are still pretty cheap today. Unit is trading at just a small premium to its much less diversified drilling brethren Grey Wolf (AMEX: GW) and Patterson-UTI (Nasdaq: PTEN), the value of which I've discussed elsewhere.
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Fool contributor Toby Shute welcomes your feedback. He doesn't own shares in any company mentioned. Chesapeake Energy is an
Inside Value
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