Oil companies took a kicking this year thanks to the collapse in the oil price.
Big market movements like that get value-inclined investors squirming in their seats, as value receptors twitch at a frantic rate around the investment community.
When companies are down on their luck and out of favour, there’s often a good chance of finding a decent investment proposition tossed out the window with the rest.
Minimise risk with the service providers
The obvious bin to sift through is that labelled ‘oil companies’, but I can understand any reticence to invest in the sector. After all, oil firms are hard to understand and analyse. Valuations tend to hinge on ‘guesstimations’ of oil in the ground, and our conventional valuation toolkit of P/E ratios, dividend yields and the like can be ineffective.
On top of that, there’s a lot of risk involved in oil exploration, things can easily go wrong, and oil in the ground, thought to be a copper-bottomed certainty, can prove to be nothing but sea water after spending millions on drilling where the chart shows the prettiest colours. Then there’s the risk associated with the oil price itself, as we are seeing now. When the price goes down, so do those oil company share prices.
There is another way. Rather than embrace all those uncertainties by investing directly into oil companies we can invest in the firms that provide oil companies with services and tools they need to carry out their operations, the ‘picks and shovels’ of the industry, if you will. By doing that we can eliminate a layer of risk associated with dry holes and industry dangers, even though oil services firms are still sensitive to the oil price.
Three of the largest London-listed oil services firms are Petrofac (LSE: PFC), Hunting (LSE: HTG) and John Wood Group (LSE: WG).
Business as usual
A persistently low oil price could affect business for the oil services providers if some oil company activity becomes uneconomic. If the sums don’t add up, oil firms will likely shelve some projects. However, the effect on business may not be as dramatic or immediate for the oil service providers because of long-term contracts.
The latest market updates from these three providers all strike a confident tone for 2015 and beyond. Petrofac and Hunting released trading statements in November, and John Wood as recently as 11 December. Although 2014 seems to have been a generally tough year for profits, city analysts following the three predict stabilisation in earnings during 2015:
|
Year to December 2015 |
Earnings growth |
Forward dividend yield |
Dividend cover from earnings |
|
Petfofac |
(5%) |
6% |
2.5 |
|
Hunting |
0% |
4.3% |
3 |
|
John Wood Group |
3% |
3.4% |
3.3 |
With the firms’ share prices well down this year, all three seem attractive due to the well-covered dividend payouts on offer. Buying now could lock in that income and leave us well positioned to ride any oil price recovery in the years ahead.
Final thoughts
Buying strong companies within an out-of-favour sector, such as Petrofac, Hunting and John Wood Group now, is one proven strategy to boost portfolio returns.