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Morningstar | Adjusting FVEs for Land Drillers; U.S.-Focused Drillers Mostly Overvalued but Nabors Is Undervalued

We're updating our models and fair value estimates for land drillers. Helmerich & Payne moves up to $41 per share from $40 per share, but the rest move down, with Nabors going to $5.50 from $6, Precision going to $2 (CAD 2.75) from $2.25 (CAD 3), and Patterson going to $10 from $13.25. Our no moat ratings for each of the names remains unchanged.

The changes come chiefly from revised U.S. land drilling forecasts. Essentially, we are increasing our U.S. land rig count forecasts for Helmerich & Payne (by about 11 rigs, or 5%) at the expense of its competitors. The company is preparing to upgrade many of its rigs to "super spec" status in coming quarters, which we think will prove successful in garnering higher utilization for those rigs. In the long run, we also think Helmerich & Payne's heightened competition will slightly degrade competitors' margins compared to our prior expectations. However, we have slightly increased our expectations for Nabors' U.S. land margins (in terms of gross margins per rig-day), owing to the company's strong performance in recent quarters.

Additionally, part of the lowering in our Nabors fair value comes from slightly more conservative international drilling forecasts. Also, about half of the reduction in our Patterson fair value comes from lower forecasts for its pressure pumping segment, which has posted disappointing results in recent quarters.

Helmerich & Payne is still very overvalued after the revision - trading about 44% above our fair value estimate. Patterson is about 25% overvalued whereas Precision is close to fairly valued. The market appears to be overrating U.S.-focused land drillers as whole still. We expect the U.S. horizontal rig count to fall from about 930 currently to around 690 by midcycle, driven by a need for U.S. shale oil production growth to moderate to more sustainable levels as well as increased drilling efficiencies. This will hold back U.S. drillers' results below market expectations. Helmerich & Payne's premium looks especially unwarranted - using our rig count forecast, the company's share of the U.S. horizontal rig count would have to grow from 27% currently to 45% in order to justify the company's current share price.

By contrast, Nabors looks very attractively valued, trading 50% below our fair value estimate. Although the company is somewhat exposed to our bearish view on U.S. land drillers, we think the market is drastically undervaluing the rest of the company, including the International Drilling segment. Nabors is not alone; several other internationally-levered oilfield services companies have plunged in valuation in recent months. We estimate that the market is currently pricing in zero rig count growth for the company's International Drilling segment, which we see as implausibly low.