Editor's note: An earlier version of this story incorrectly stated that Helmerich & Payne did not have any international operations. The article has been updated to reflect the correction. We regret the error.
Readers have encouraged me to broaden the scope of the land drillers I cover, so today I'll take a look at one of the larger players that has gone uncovered by the Fool in recent years.
You can't take venerable to the bank
Parker Drilling (NYSE:PKD) is a venerable firm that stretches back three generations of Parkers. The company has severely underperformed its peers over the long term, turning in a roughly flat return for shareholders over the past 10 years. The company had managed to run up a roughly 75% debt to capitalization ratio by 2002, which is around when things were looking most grim for the Parker clan.
To some, this is all ancient history. The past four years or so have seen Parker execute an impressive turnaround, bringing that 75% debt figure down to 43% today. Multibagger returns have resulted from the firm's recent return to profitability. To get a better handle on where this company is going, I'm going to primarily drill down on the past few years, while keeping the longer-term woes firmly in mind. History doesn't so much repeat as rhyme.
International exposure: Boon or burden?
In its 2006 annual report, Parker describes its leverage to international drilling as "a key element differentiating Parker from U.S. land drillers." I would agree with that. Over the past several years, the lower margins that Parker has earned in its international drilling segment do indeed differentiate it from North America-only peers such as Grey Wolf (AMEX:GW). But I don't suppose the company meant this differentiation to be a good thing. Looking to the future, it finally may be.
Parker has always pointed out how the specific features of international land drilling make it an ideal fit for the company. There's historically been a lower level of competition that's only now ramping up, as oil and gas prices persist at elevated levels. Targets often lie in remote, difficult-to-drill locations, which should be to Parker's advantage, thanks to its technical leadership in heli-rigs and experience in harsh environments ranging from the jungles of Papua New Guinea to the Western Siberian arctic. Economically, the company points to the prevalence of longer contracts and higher dayrates than those available in the U.S. land markets. All of this framing makes the company's failure to secure decent margins abroad all the more puzzling.
Parker must see a brighter future for the international land drilling segment, because the company is ramping up spending on new rigs as part of its strategic growth plan. I'll have more to say on that strategic shift in a moment. Now, this segment has been earning gross margins in the low-20% range in recent years amid record high commodity prices. What could possibly make it more profitable in the future?
Parker ought to be a prime beneficiary of the development of a global market for natural gas via liquefied natural gas (LNG) tankers and terminals. Hitherto-stranded gas reserves will be transportable by sea and more valuable as an alternative to crude oil. On the flip side, the company will undoubtedly face increasing competition the further along the development of the LNG market goes. There's a net benefit here for sure, but new entrants will temper rising dayrates, as night follows day.
One good year and the checkbook's open
In Parker's dark days of indebtedness, it launched a program to reduce debt by $200 million and minimize capital expenditures. It also laid off quite a lot of employees. After netting out the several hundred employees who transferred directly to former subsidiary Hercules Offshore (NASDAQ:HERO), headcount is still down about 20% since the start of the decade. Contrast that to a company like Rowan (NYSE:RDC), which has never incurred layoffs and has been around just as long as Parker. Although those layoffs may come back to haunt the company, given the shortages of skilled labor now plaguing the industry, Parker can be lauded for tightening its belt and working off a lot of debt.
In 2005, Parker had its first bonanza year in quite some time. A lot of that lucre stemmed from the Gulf Coast hurricanes, but the company chose to attribute its results to its own efforts, as if it had raised rig utilization and dayrates through sheer force of will. The company even went so far as to champion results "in spite of the adverse consequences of three hurricanes." Parker got lucky, didn't get much equipment wrecked, and reaped the rewards of elevated rates.
With the profits flowing again, Parker has notably shifted its strategic priorities in short order. As recently as 2004, the company's strategy contained language of "limiting capital expenditures," and "strategic growth" was listed last out of four items. Come 2005, strategic growth rocketed to the top spot, and the capex language was loosened to allow for "efficiency-based" spending.
Parker has not generally proven to be a disciplined allocator of capital in the past. At the first sign of a turnaround, the company chose to massively ramp up capital expenditures to roughly $200 million in 2006, up from recent sub-$50 million levels and the highest since 1998. Maybe the company knows what it's doing this time. But here's a line from the 2006 annual report that makes me skeptical of the company's stated commitment to improving returns on capital: "Although the initial period of this [Saudi Arabian] joint venture will not generate significant profits or cash flows, it is part of the strategic growth in targeted markets set forth in our five-year plan." Market share and returns on capital are generally divergent strategies, and I don't like the company's choice here.
A bright spot or two
Besides Parker's leverage to LNG, there are some other things to like about this company, particularly its equipment rental business Quail Oil Tools, which sports higher margins than any other segment. If Parker is really serious about tethering its fortunes to international drilling, it should probably spin off Quail Oil Tools or sell it to a competitor like Superior Energy Services (NYSE:SPN). While a sale would allow the company to pursue its growth plan without ratcheting indebtedness back up into the danger zone, a spin-off could be the most shareholder-friendly course of action.
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Fool contributor Toby Shute doesn't own shares in any company mentioned. You can take the Motley Fool's disclosure policy to the bank.
