Even though Helmerich & Payne (NYSE:HP) and Transocean (NYSE:RIG) are technically in the same industry of supplying drilling rigs to oil and gas producers, the markets to which they rent those rigs couldn't be further apart. One is reaping the benefits of North America's shale boom, while the other's business is suffering in large part because of it.
Ironically, both of these companies have the traits investors want: A premium product in a typically commoditized business, and good management teams leading the way. By that measure, investors probably wouldn't do poorly with either stock. The most significant difference between the two is how much you value risk versus reward, so let's take a look at why these companies are worth considering and which stock suits your investment style.
The common thread
Despite the fact that these two companies serve two completely different parts of the oil and gas market, they have a few things in common. One thing is that they both have similar business models. As rig companies, they lend out their rigs to producers for a daily rate that's either agreed upon with a long-term contract, or on shorter-term deals where the rate is based on a spot-market price.
Another thing that these two stocks have in common is that they have a similar approach to their respective markets. Transocean and Helmerich & Payne both have fleets of rigs that are designed to handle the more complex and challenging drilling jobs. Transocean's rigs can drill in waters as deep as 10,000 to 12,000 feet and in harsh environments like the North Sea and the Arctic. Helmerich & Payne has rigs that can precisely and quickly drill long horizontal wells in what can be relatively thin layers of shale rock.
By selling to the higher end of their markets, both companies get two advantages: 1) They both tend to work with larger, better-capitalized companies, which reduces the risk of a counterparty not paying its bills; and 2) more challenging drilling jobs mean higher dayrates -- which means higher margins.
It's also worth noting that both of these companies have excellent management teams that have steered these businesses through difficult times. At Transocean, CEO Jeremy Thigpen has done a remarkable job transforming the company's fleet from an older, less-capable one into one that's technologically advanced and specifically targeted at those deepwater environments. Investors should also give a tip of the cap to Helmerich & Payne's management for maintaining incredible financial discipline throughout this downturn and preserving its dividend streak.
The differentiating factor between these two is the respective markets they serve, and how those markets will likely play out in the coming years.
The more-certain bet
Determining which of these two companies will have a better future depends on where producers want to spend their investment dollars. Fortunately for Helmerich & Payne, those dollars have increasingly gone toward shale drilling in North America.
Shale wells have a couple of inherent advantages over offshore. It takes much less time to drill, the cost for an individual well is much less, and there's already a robust energy infrastructure in place to move oil and gas to end markets. These characteristics are attractive to producers because they don't have to tie up billions in working capital, and a single dry well is much less costly than a dry offshore one.
Ever since we started tapping shale for hydrocarbons, the drawback was that the per-barrel cost of shale was much more expensive than anything else. In a roundabout way, though, this most recent oil crash was exactly what the industry needed. Companies became much more cost conscious and focused heavily on lowering the break-even cost. So much progress has been made on this front that the same well that used to require $90 a barrel to break even now requires $50 a barrel, or less.
What's even more important is that shale has surpassed other sources as the less-expensive option, namely offshore. In fact, in a recent Chevron investor presentation, the company said that 9 million barrels per day of the next 13 million barrels per day of production to come on line will likely come from North American shale.
This plays almost perfectly into Helmerich & Payne's hands. Not only does it have a fleet of rigs that can drill these shale formations, but it also has more than 100 idle rigs it can put to work. So it's relatively safe to say that Helmerich & Payne has a bright future ahead of it.
Greater stock potential
Just about everything I said above is a case against offshore. There's a good chance that shale will take the lion's share of the next several million barrels of oil to come to market -- and shale is less costly than offshore.
However, there are signs that the offshore industry is getting better at controlling costs. Also, the market is pricing the offshore market as if it's going to die.
Lowering costs for an offshore reservoir isn't something that can simply happen overnight, but there has been a lot of progress in recent years to make offshore a more competitive oil source in the years to come. Some of the industry's largest initiatives -- rig and equipment standardization, floating storage terminals, and more efficient equipment designs -- have taken a serious bite out of the cost to drill a well. A great example is BP's Mad Dog 2 design.
When the project was initially designed, it was supposed to cost $22 billion. After going back to the drawing board, the project now expects to cost closer to $14 billion. If companies continue to lower costs like this, offshore will be much more competitive down the road.
On top of that, there's another thing to consider. Shale may not be able to supply all of the world's growing demand. As prolific as North American shale has proven to be, investors need to keep in mind that the world uses a little less than 100 million barrels per day. Current supply dissipates every day from the natural decline of reservoirs. If offshore can continue to lower costs, and shale can't meet all of the needs of the global market -- and chances are it won't -- then offshore is likely going to play a significant role in the market.
From an investing perspective, it's pretty clear that betting on offshore is a riskier investment, but the market is giving investors a hefty discount if it wants to take that bet. Today, shares of Transocean trade for 0.36 times tangible book value, which is like Wall Street saying that Transocean is worth less than its current liquidation value.
With shares trading at such a substantial discount, investors could make a sizable return with Transocean's stock if the market for offshore drilling were to take off again.
What a Fool believes
It would be hard to fault an investor for picking one of these two stocks. Both Transocean and Helmerich & Payne have desirable qualities that an investor would want from a company in the oil and gas industry. It all comes down to one's risk tolerance and outlook for the oil industry.
For those looking for a more certain outcome, then Helmerich & Payne is the better bet. The company's 4% dividend yield is a good indication of the company's strength. However, if you have an appetite for risk and have a relatively bullish outlook for the oil industry over the next decade or so, Transocean and its dirt-cheap stock look incredibly attractive.