Model Portfolio athompson:TPSNX

Drilling for Dollars

by Adam Thompson, m10 member and mFOLIO Master

You can see from Adam Thompson's Performance Zones (click here), that 41% of his gains have come from the Energy Sector. So when he writes about a stock in this sector we listen.

I believe that global demand for oil will continue to increase over the next several years although there might be a lot of volatility along the way. That’s why I have 34% of my portfolio in energy stocks. But drillers have been hit hard over the last year from the oil and gas price volatility and right now, I believe there are better buying opportunities with drillers than with exploration and production stocks. As long as the price of oil doesn’t drop back to the $40s, we’re still opening up new wells and re-opening old exhausted wells and drillers will be in demand. So even if oil prices don't increase and remain relatively high we can benefit and we should have some downside protection as long as oil doesn't drop fast, far, and fairly permanently.

Patterson-UTI Energy (nasdaq: PTEN) provides oil drilling services to oil and natural gas producers. It operates 403 rigs, giving it the second largest land-based drilling fleet after Nabors Industries. Oil and gas drilling stocks in general have fallen considerably over the last year. Patterson-UTI is down to $22.04 (3/12/07) from its high of over $35. I believe this is a considerable overreaction. Petroleum prices have declined, but it's still very profitable to drill for oil and gas at the current prices of almost $60 per barrel for oil and over $7 per thousand cubic feet for gas. These prices, and Patterson-UTI's profits, will undoubtedly fluctuate, but I believe the current trend is up. I think the world economy will continue to grow, especially in China and India, and these countries will use more and more oil as they become more industrialized and more of their residents buy cars. It's also likely that U.S. consumption of natural gas will continue to increase. For one thing, the population is shifting to the South, with its high air conditioning use. More energy will be needed for all those air conditioners, and at least some of it will come from natural gas. How much comes from natural gas will depend on political factors and public attitudes toward pollution (natural gas is much cleaner than energy sources like coal) and nuclear power.

Patterson-UTI earned $4.02 per share in 2006, giving it a P/E of less than 6. That's the P/E of a stock that the market has very low expectations for. But I think Patterson-UTI has good long-term prospects, even if 2007 is somewhat uncertain. These good long-term prospects also make Paterson-UTI an attractive takeover target, I believe.

Disclosure: I hold this stock in my own accounts and in most of my clients' accounts.