These Three Oil Service Companies Offer Stunning Value

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 all good news in particular for National Oilwell Varco (NOV -0.16%) and Cameron International (CAM.DL), both of which are specialists in their own field of production, and considered by Goldman to be some of the most undervalued stocks on the market. National Oilwell manufactures the drilling equipment, and Cameron produces the high-tech sub-sea systems and blow-out preventer's that are key for drilling operation. 

This is also good news for the world's second-largest offshore drilling company Ensco (VAL), 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 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'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'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 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's backlog is worth two-and-a-half years of revenue at current rates, National Oilwell's backlog is worth three-quarters of revenue at current rates, and Cameron'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 trades at a PEG ratio of 1.1, Cameron trades at a PEG ratio of 0.96, and Ensco trades at a PEG of 0.6. 

Valuations are below average  

As shown above, all three companies trade at valuations below the industry average. That said, Cameron 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.

Foolish summary 
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 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'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.