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Is This the Best Turnaround Play in the Energy Patch?

By Reuben Gregg Brewer – Sep 17, 2020 at 9:09AM

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Looking for a way to play rising energy prices? There's one name that stands out -- you just need to understand what you're getting into.

Oil and natural gas prices are at painfully low levels, leading the broader energy sector into a brutal downturn. That means contrarian investors, who often invest while others are afraid to, should probably be sniffing around for deals. If that sounds like you, then it's time to take a closer look at Helmerich & Payne (HP 1.41%). It is, perhaps, one of the best ways to play an energy upturn.

Some basics

Oil and natural gas are commodities subject to the dynamics of supply and demand. There's no question that the energy sector today is in a state of turmoil, with oil prices actually falling below zero at one point earlier in 2020. There were technical reasons for that drop, but the implications are kind of frightening -- for a brief moment in time, oil producers were paying customers to take their oil. 

A man with a notebook in front of oil well

Image source: Getty Images

That dislocation was driven by the global economic shutdowns used to slow the spread of COVID-19. Effectively, that led to a sharp contraction in demand for oil and natural gas. All of the extra fuel being produced got shoved into storage, leaving a lingering overhang of supply to sop up. There are two basic ways to get supply and demand back into some semblance of balance. One is to increase demand, which is starting to happen as economies reopen. The other is to cut back on supply, which is also happening, particularly in the U.S. onshore space.

Because of where the world is in the pandemic situation, demand is likely to take some time to recover. So supply cuts are going to be a vital piece of the energy sector puzzle. To simplify things, U.S. non-conventional energy production (generally referred to as fracking) is one of the easiest production methods to ramp up and down. It shouldn't be that surprising, then, to see a massive pullback in the U.S. onshore sector as a result of the current supply/demand imbalance. Helmerich & Payne is one of the largest drilling services companies in the U.S. onshore space.

The hit and the potential

How bad is it today for Helmerich & Payne? Of the roughly 300 rigs this company owns, only about 25% are currently operating. A few years ago that number was usually well over 80%. It's so bad that the board of directors cut the dividend by 65% after decades of annual dividend increases. Oil drilling is a highly cyclical industry, and Helmerich & Payne had weathered the ups and downs in stride before, while still growing its dividend. So the current downturn obviously has the company pretty worried about the near-term future. 

However, just how worried does Helmerich & Payne need to be about the long term? As it stands, the company's debt to equity ratio is a very strong 0.15 times or so. That's materially better than those of any of its closest peers, and, frankly, low for just about any company in any industry. Meanwhile, the company's cash balance actually went up through the first nine months of fiscal 2020 as it's worked to cut costs and preserve liquidity. Notably, there were no material debt issuances or stock sales. In fact, Helmerich & Payne actually bought back some shares. At the end of its fiscal third quarter, management highlighted that it had roughly $500 million in cash and short-term investments, and no amounts drawn on a $750 million credit facility, providing it with about $1.2 billion worth of liquidity. All in all, it looks pretty likely that Helmerich & Payne is going to weather this downturn like it has weathered industry downturns before. 

HP Debt to Equity Ratio Chart

HP Debt to Equity Ratio data by YCharts

Meanwhile, the company has long focused on keeping its rig fleet at the leading edge technology-wise. Roughly 90% of its U.S. land fleet is made up of what are referred to in the industry as "Super Spec" rigs. These are the most flexible and efficient drills, and are the ones that are, as you would expect, seeing the most demand from customers. Notably, Helmerich & Payne is a market share leader in the U.S. onshore space, working with some of the biggest players in the energy industry. When drilling picks up again, its fleet of high-end rigs are highly likely to quickly get put back to work. 

For the oil believer 

When you put it all together, Helmerich & Payne looks like it will easily survive this deep downturn. And when the energy markets pick back up again, it will be there with a well-positioned drill fleet to prosper from the rebound in an oil region that has proven it can quickly ramp up its production.

There's just one fly in the ointment here: You need to believe that supply and demand will eventually balance out again, and that drilling activity will, indeed, head higher as a result. However, if that sounds reasonable to you, then Helmerich & Payne could easily be one of the best turnaround options in the energy sector today. 

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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