It's painful to watch when an industry goes from being valued on robust cash flow growth assumptions to more conservative replacement cost models, but that appears to be what's happening in the land-based drilling space. That's not great news if you're a Patterson-UTI (NASDAQ:PTEN) shareholder.
If the overall valuation philosophy is in fact changing, that's probably doubly frustrating given the strong performance to date from this driller. Revenue was up 63% this quarter and operating income more than doubled as the company continues to not only maintain market share among the likes of Nabors (NYSE:NBR), Parker (NYSE:PKD), and GreyWolf (AMEX:GW), but also reap excellent margins from this tight services market.
What isn't always appreciated about Patterson is that it's not just a drilling company. Granted, drilling provides the lion's share of revenue, but the company's pressure pumping and fluids businesses are growing nicely as well. What's more, I can only speculate on this point, but I would imagine this is a real growth opportunity -- Patterson typically deals with small clients and I just don't know if service giants like Schlumberger (NYSE:SLB) or BJ Services (NYSE:BJS) want to deal with the so-called "checkbook operators."
These are dangerous times for land drillers. Gas storage and production numbers have been looking good and that could threaten gas prices going into the winter if there isn't a bad hurricane season. On top of that, supply continues to come into the market, and while Patterson has the advantage of reactivating rigs at a lower cost than building them, more supply is still more supply.
Truth be told, Patterson-UTI shares are probably too cheap today. There will be good growth for years to come in drilling activity and today's price probably discounts the company's cash flow leverage over a full cycle. That said, arguing with the market can be about as rewarding as arguing with an oncoming train, and so investors should exercise some caution with a stock in a sector that Wall Street seems very nervous about right now.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
