Playing the C&J Energy Services Breakout

For a couple of years now, C&J Energy Services (NYSE: CJES  ) has had the potential to be a top oil services stock benefiting from the shale boom in the U.S. Unfortunately, low natural gas prices have pressured margins and held the stock of this budding hydraulic fracturing specialist in check during the last two years.

C&J Energy is a leading provider of premium hydraulic fracturing, coiled tubing, pressure pumping, wireline and other complementary completion services. The company has a focus on the most complex and technically demanding well completions. C&J Energy has a strong presence in the Bakken Shale, Eagle Ford, and Permian Basin. The recent results from multinational oil service firms Baker Hughes (NYSE: BHI  ) and Schlumberger (NYSE: SLB  ) have pushed the sector higher, but analysts from Cowen & Co cut the rating on C&J Energy due to expected pricing pressure. The stock continues to break out with expectation of a better pricing environment in 2014 contrary to the Cowen call.

More wells, less rigs
The ongoing theme in the drilling sector has been the shift to more efficient drilling rigs that can drill multiple wells from one pad. Baker Hughes even updated an industrywide rig count report to include well counts. In the third quarter, the report showed a gain of 164 wells drilled compared to the previous quarter with the same 1,709 drilling rigs. Interestingly, the well count actually dropped by 236 wells from the 9,411 wells drilled last year.

The most encouraging part for C&J Energy Services is the strength being seen in the Permian Basin, the Williston Basin, and the Eagle Ford Shale.

Strong results from sector leaders
The sector leaders reporting so far this earnings period have shown strong results. The biggest concern for a domestic player like C&J Energy is that the gains come from foreign locations. Schlumberger is obtaining all those gains from growth in the Middle East and Africa. On a positive note, both Baker Hughes and Schlumberger suggested that the land drilling overhang is finally being worked off with customers more interested in taking higher-priced, high tech solutions.

In the case of Baker Hughes, it saw a sequential 6.7% increase in North America revenue. This revenue growth led to substantially higher operating profits compared to last quarter. The numbers weren't favorable to last year, but the slight decrease in operating profits is encouraging.

For Schlumberger, third quarter results reached new highs in both revenue and pre-tax operating income, yet the company directly called out continued pricing weakness in the North American land market. North America generated a 7% sequential increase in revenue, similar to Baker Hughes. Management specifically mentioned offshore Gulf of Mexico drilling as a driving force for growth. Not a good sign for the land-focused oil service stocks.

Developing story
C&J Energy remains a mostly unknown story. As with any drilling services company, hitting targets can be part luck, based on the general shifts in the market. The interesting part about this company is that it has continued to expand even during the downturn. The premium hydraulic fracturing fleets went from five at the end of 2011 to nine in less than two years. The total horsepower jumped from 164,000 toward the end of 2011 to 302,000 currently for a nearly 85% increase in capacity. In addition, it made the large Casedhole Solutions acquisition, which is now expanding wireline capacity.

The public market likely has a negative perception of the stock having mostly reported declining profits during this period. Importantly though, the company has still been able to generate solid profits and huge cash flows. In the last 12 months, it has been able to reduce debt by around $67 million during a period of likely trough margins.

Bottom line
The recent well count reports suggest the demand for land drilling services is leading to potentially stable pricing. Unfortunately C&J Energy doesn't participate in any of the strong international markets that have benefited the likes of Baker Hughes and Schlumberger. A major catalyst for C&J Energy could be a much-anticipated expansion into the Middle East that could occur next year. Combined with higher utilization of the new fleets, the stock has several catalysts in place to push it higher.

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