Key Energy Services: Will a Government Investigation Create a Long-Term Opportunity?

You might think Key Energy is a value investment opportunity, but make sure you read this before coming to any such conclusions.

Jun 11, 2014 at 1:14PM

Key Energy Services (NYSE:KEG) provides onshore well services with more than 175 locations in the United States. The stock has fallen more than 20% from its 2014 highs. These losses are a result of poor fundamental performance relative to other onshore drilling companies and also the possibility of corruption that could unmask significant problems for the company. Should you see its losses as an opportunity or seek value in its peers such as Basic Energy Services (NYSE:BAS) and Nabors Industries (NYSE:NBR)?

An unraveling puzzle with unanswered questions
Key Energy is currently investigating allegations involving its Mexican operations for possible violations of the U.S. Foreign Corrupt Practices Act. Furthermore, Key Energy has voluntarily disclosed the allegations and information surrounding the situation from its initial investigation to the U.S. Securities and Exchange Commission.

This disclosure only adds to the controversy surrounding this company, as the same allegations emerged last month in regard to its Russian business. According to a recent 8-K filing, an investigation has been launched by the SEC and U.S. Department of Justice, and the company claims that it is fully cooperating.

Nonetheless, there are no additional details as to what this corruption may include, which leaves the situation open to speculation. With that said, it is rather serious to have two different enforcement agencies of the U.S. government conducting an investigation and equally serious to have the same problem surface in two separate regions of its business in different countries.

As a result, investors can only assume that as this puzzle unravels, even more troubles could come to light, such as the possibility of corruption or further issues with the way Key Energy does business. Therefore, it's rather difficult to call the stock a buying opportunity right now with so many unanswered questions, especially when compared to peers.

Two investment options with actual growth and without controversy
Nabors Industries and Basic Energy Services are two other large land-based drillers, both of which have trended in a different direction than Key. As you can see, Key Energy has significantly underperformed its peers, and while its stock has seen a pullback in the last couple months, its underperformance can be traced to more than just an investigation.

For example, in Key's first quarter, its total revenue fell nearly 17% year over year to $356.1 million as the company struggled with concluding international contracts. In retrospect, its U.S. business isn't that bad, with flat revenue and an operating margin of 11%; although that's still down from 14.5% last year. However, it's the lagging international business that is killing Key, with a negative operating margin of 32.7%.


Key Energy Services 1 Year Total Returns data by YCharts

In comparison, Basic Energy and Nabors have been solid companies. Basic Energy's revenue increased 10.6% in its last quarter, while Nabors' declined 3.7%. On the other hand, higher oil prices and improved well utilization rates are expected to bode well for the two companies, with analysts projecting full-year revenue growth of 6.7% and 12.8% for Nabors and Basic Energy, respectively.

Foolish thoughts
With that said, it's really hard to find a reason to invest in Key with so much uncertainty and fundamental declines. Basic Energy is growing much faster, has higher margins, and trades at the same 0.8 times sales premium. And while Nabors is more expensive at 1.3 times sales, its operating margin is about triple that of its peers, at 8.5%, and its 14 times forward earnings multiple is rather attractive. Therefore, why chase Key when there are two solid alternatives, especially with two agencies investigating its operational practices?

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Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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