Capitalize on the Offshore Drilling Recovery With National Oilwell Varco

The downturn in the offshore drilling industry has had a negative impact on the construction of rigs, which has negatively impacted those companies that sell parts for these rigs. However, the downturn should be short-term, and when the industry returns, so will equipment orders. Here's how to profit from this.

May 27, 2014 at 12:05PM

Over the past few years, there was a boom in the offshore drilling sector. Due to this, offshore drilling companies began construction on an enormous number of offshore drilling rigs. Naturally, this also led to an enormous demand for equipment for these rigs, such as that manufactured by National Oilwell Varco (NYSE:NOV).

Of course, as many of you know, this boom ended around the end of last year, and the offshore drilling sector is currently in a slowdown; this has naturally resulted in offshore drilling contractors ordering fewer rigs from shipyards. This has in turn led to a reduction in the demand for equipment for these drilling rigs. 

This is one reason why National Oilwell Varco recently stated that it expects rig technology orders to decline this year compared to last. However, this slowdown is likely to be short term, and once the industry speeds up again these orders will likely increase. Thus, we could be seeing an opportunity to buy into the stock of an excellent company on weakness.

Causes for industry slowdown
There were a few causes for the slowdown in the offshore drilling industry. A large number of newbuild rigs entered the worldwide fleet at a time when large oil companies have been seeing constrained cash flows due to escalating costs of maintaining their current production. This resulted in oil companies demanding fewer rigs to develop their offshore oil fields just as large numbers of new rigs were entering the world's rig fleet. The supply of rigs is now greater than the demand for them, which is a stark reversal of the situation that was present over the previous few years.

Downturn likely to be short-term before returning to growth
This naturally caused offshore drilling contractors to stop purchasing as many rigs to prevent supply from getting too far ahead of demand. However, by all indications, this downturn is likely to be a short-term one. National Oilwell Varco essentially stated this in its first quarter results with its statement that all the "easy oil" has been found, so future oil production will depend heavily on unconventional plays such as ultra-deepwater fields.

The consumption of oil worldwide isn't going anywhere anytime soon, so the activities of oil companies in these areas must increase as more conventional fields steadily decline. As the oil companies steadily increase their activities in the offshore space, particularly in ultra-deepwater areas, contractors will be forced to construct more rigs. They will thus require equipment produced by National Oilwell Varco and its peers Cameron International (NYSE:CAM) and Schlumberger (NYSE:SLB).

Morgan Stanley and leading offshore consulting firm Rystad Energy agree with this, projecting that the demand for offshore drilling rigs will once again begin to exceed supply by 2016-2017. This will lead offshore drilling contractors to begin constructing an increasing number of drilling rigs, which should prove accretive to National Oilwell Varco's forward growth.

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Source: Morgan Stanley, Rystad Energy, Seadrill

Cheap stock
National Oilwell Varco's stock price fell following its first quarter earnings, but it rebounded somewhat in the days following. The company's stock currently trades close to its 52-week high. However, it could still offer a good value at the current price due to its relatively low P/E and high dividend compared to many other potential investments. At the time of this writing, National Oilwell Varco has a P/E of 14.67 and a dividend yield of 2.30%.

Other ways to play the investment thesis
National Oilwell Varco is not the only way to play the return of the offshore drilling industry as both Cameron International and Schlumberger make equipment for offshore rigs. Cameron currently trades with a P/E of 22.79 and pays no dividend. Schlumberger trades with a P/E of 19.06 and has a dividend yield of 1.60%. As such, National Oilwell Varco looks to be the cheapest company among these options.

The best play on offshore drilling?
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Daniel Gibbs has no position in any stocks mentioned. His research firm, Powerhedge LLC, has a business relationship with a registered investment advisor whose clients may have positions in any of the stocks mentioned. Powerhedge LLC has no position in any stocks mentioned and is not a registered investment advisor. The Motley Fool recommends National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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