Precision Drilling's Cautious Optimism

Motley Fool Global Gains selection Precision Drilling Trust's (NYSE: PDS  ) first-quarter earnings are well below last year's results. The results should come as no surprise, though, as last year was among the best ever in the drilling industry.

Precision drills for natural gas and oil on a contract basis, with most of its efforts focused on natural gas. For the quarter, revenue declined 23.5% to 410.5 million CAD ($368 million) and operating earnings declined 27.5% to 178.2 million CAD ($160 million). The decline in revenue is because of a decrease in demand for natural gas drilling. Earnings per share declined 29.6% to 1.29 CAD ($1.16), because interest and tax expenses declined at a slower rate than revenue and operating income.

The quarter's results could have been worse had Precision not managed to reduce its operating expenses at a rate close to its decrease in drilling activity, thereby holding prices at levels similar to last year. However, the company is already seeing signs that it will not be able to continue its current pricing levels in the second quarter.

The second quarter is normally a soft one for Precision and other drillers in Canada because of road bans. The road bans don't allow vehicles over a certain weight to use the roads while the ground thaws and settles. This keeps the roads from getting deformed, but it also means a forced period of inactivity for drillers and others that need to move heavy equipment. Since this year has seen lower drilling activity, the soft second quarter will be a bit tougher for companies that need to remain active and absolutely have to keep cash coming in to cover fixed expenses such as interest on debt. If this scenario plays out, some drillers are likely to be aggressive on price to ensure drilling work and cash flow.

Precision is OK from a cash flow perspective and should feel less pain than more leveraged drillers. The company carries a light debt load of 147.7 million CAD ($133 million) and has 389.4 million CAD ($349 million) in accounts receivable. Likely pricing declines aren't good news, but there are signs they will be short-lived. Natural gas inventories are 10% below year-ago levels, drilling activity has slowed, and spot prices for natural gas have begun to recover from the lows seen early in the winter. The combination of factors leads me to believe that any decline for Precision is likely to be temporary.

In the long term, there are no signs that energy usage will decrease globally, and imports of energy from Mexico are declining as well. Pair this with long-term demand for natural gas, because it is a cleaner form of energy, and you have a healthy long-term demand picture for drillers.

Precision has had a tough 12 months, with the Canadian government's decision to start taxing income trusts as corporations in 2011 and the slowdown in drilling activity happening almost simultaneously. The price and inventory levels of natural gas drive the demand for drilling companies such as Encana (NYSE: ECA  ) and Canadian Natural Resources (NYSE: CNQ  ) in the market. In the long term, Precision's position as one of the largest drillers in Canada, its experienced management team, and its conservative balance sheet help to make it an attractive long-term opportunity in the industry.

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Nathan Parmelee has no financial interest in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.

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