Share tip of the week: oil services will gush profits

published 24 December 2008

With sterling looking about as attractive as a New Year's Day hangover, one of my investment priorities for 2009 is to find British stocks with sound balance sheets, that generate lots of cash and make a big portion of their profits from overseas markets. The tip below, in the out-of-favour oil services sector, offer these qualities in spades.

Hunting (LSE:HTG), tipped as a BUY by FinnCap

First we have Hunting, which last Monday completed the delayed £617m sale of its Canadian unit Gibson Energy to Riverstone, a US private-equity group. The disposal could not have been better timed. It was agreed in the summer when the oil price was still way above $100 a barrel. Now that the oil price is back down to about $40, I'm sure Riverstone is kicking itself for paying top dollar or 13 times peak-cycle operating profits for Gibson's trucking and refining assets, which were mainly focused on handling heavy oil and the Athabasca tar sands.

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So with 90% of the money already paid, where does this leave Hunting? Its strategy is to grow its upstream activities both organically and by acquisition. In fact, it is already one of the world's top suppliers of specialist drilling equipment for hard-to-access oil and gas fields (using deepwater and high-pressure rigs, for instance) and owns 43 technology patents on its popular mud-motors. With the company's bank account now flush with around £360m in net cash (worth 270p per share) there's plenty of fuel left in the tank to ramp up earnings-enhancing acquisitions while sentiment is so poor.

Clearly, 2009 will be much tougher, with the industry set to shrink, especially within North America, where customers are already cutting back on exploration. Yet this harsher climate could actually play to Hunting's advantage, as it will surely hasten industry consolidation. Either Hunting will act on its plan of snapping up tasty rivals at low prices; the board is already working on several possible deals in Europe and North America. Or alternatively and I suspect this outcome is more likely in light of the stock's battered valuation one of its larger rivals, such as Schlumberger, will launch an opportunistic bid while Hunting is vulnerable.

So how much is the business worth on a standalone basis? I would value Hunting on a through-cycle multiple of ten times operating profits, which together with its cash pile, generates an intrinsic worth of around £760m, or 570p per share. Assuming trade buyers could also extract the usual cost synergies (from combining operations), then I would not be too surprised if Hunting was taken over in the next 12 months for somewhere north of 650p.

So what do we need to watch out for? Firstly, if the level of drilling activity worldwide were to dry up then this would undoubtedly have an impact on performance. Next, the vast majority of the company's operations are based outside Britain, so there are foreign-currency risks to consider. All the same, with the trend for greater energy consumption still intact, long-term demand for Hunting's top-notch products is set to continue.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.