Drilling down for new energy plays

It takes more than exploration and production to get oil out of a well and into a gas tank.

By InvestorPlace Jan 22, 2013 2:27PM

Filling fuel tank copyright CorbisBy Aaron Levitt

iplogoThe advanced drilling revolution continues to transform North America's energy landscape. Drilling techniques like hydraulic fracturing and horizontal drilling have set off a modern day gold rush as exploration and production (E&P) companies fight for acreage in America's various shale rock formations. This geology is the key for long-term profits and reaching our goal of energy independence.  

However, the shale boom is looking a little thin.

No, it's not going away time soon -- it's far too big -- but it has begun to show signs of maturity, and some analysts predict that the trade has become crowded. 

Aside from M&A activity, it's becoming difficult to move the needle in a significant way. Over the next few years, shareholders in E&P companies like Range Resources (RRC) may not realize the outlandish capital gains they have become accustomed to.

It takes a lot of work, technology and money to get energy out of the well and into our gas tanks, and the E&P companies are just one step in the process. As the domestic energy boom matures, some ancillary players are going to become very attractive.

Here are some of the top picks in the services sector:

Geospace Technologies

In order to tap our nation's abundance, first you have to find it. That's where Geospace Technologies (GEOS) comes in. The firm -- formally known as OYO Geospace -- designs and sells seismic equipment used to detect pockets of hydrocarbons.

Energy companies have been using seismic data since the 1920s to identify various geological conditions that are favorable for oil/natural gas and to evaluate their various drilling potentials. In recent years, the use of advanced 3D seismic-data equipment has been crucial to the discovery and development of the pockets of natural gas in shale formations.

Geospace's shares have jumped about 81% over the last six months as the company continues to rack up new contracts with firms like Statoil (STO) and Dawson Geophysical (DWSN), as well as expand its revenue base.

While shares of GEOS aren't cheap at a price-to-earnings (P/E) ratio of 33, they're less expensive than many rivals across a multitude of metrics -- including return on equity (ROE), price-to-sales and price-to-book ratios. Overall, Geospace makes an ideal way to play the shale boom as it matures.

Dynamic Materials

Cute ticker aside, Dynamic Materials (BOOM) could indeed put a boom into any energy portfolio.

The firm is one of the only companies to provide "explosion welding" to the oil and gas industry. The intense pressures of drilling, refining and gathering energy, requires intensely made equipment. Dynmaic Materials uses its proprietary techniques to weld a variety of pieces in the energy value chain. The explosion weld fuses the pieces of metal together -- including metals that can't normally be arc welded -- into one solid piece.

Dynamic Materials also provides various explosives to oil field operators for pipe recovery, well-plugging and seismic applications, and it has a more traditional welding-for-hire service.

BOOM is virtually unknown to most investors and can currently be had for a P/E of 17 and a 1% dividend.

Patterson-UTI Energy

Falling onshore rig counts caused shares of contract driller Patterson-UTI Energy (PTEN) to fall as well. However, as the number of drill rigs in operation has risen and the latest Energy Department's weekly inventory release showed a larger-than-expected decrease in natural gas supplies, PTEN has been riding high. There are plenty of reasons to believe that will continue.

Analysts at Susquehanna estimate that the possible rebound in U.S. drilling activity will benefit Patterson the most -- not only because it's one of the largest onshore contract drillers, but also because the company has favorable drilling contract rollovers coming due, not to mention that these rollovers will have limited cost impacts on the firm’s bottom line.

That will help pad shareholders as well as Patterson's bottom line. PTEN can be had for a dirt cheap P/E of 9.

Exterran Holdings

Exterran (EXH) is another ignored oil-services firm. However, investors may want to put it on their lists.

EXH is one of the largest providers of natural gas compression equipment and services in the world. After extraction, natural gas needs to be "squeezed" in order to send it through pipelines and other midstream infrastructure. The company also provides the various pieces of equipment needed to process that gas once it's out of the ground and compressed.

As producers have shifted away from dry gas and toward shale oil, the demand for Exterran's compression services has dwindled. However, as more wells are tapped in dry gas regions -- like the Marcellus -- E&P companies should be calling Exterran in spades.

The company also has another ace up its sleeve: a master limited partnership (MLP) subsidiary. Exterran Holdings is the general partner of Exterran Partners (EXLP), which provides contract compression services. Those contracts result in hefty tax-deferred distributions for EXH.

All in all, Exterran is an interesting pick to play the well after the initial drilling has been done.

Lufkin Industries

You know those stereotypical oil field "beam-style" pumps, swinging up and down across Texas fields? Yeah, Lufkin Industries (LUFK) makes those -- along with a whole host of other sophisticated pumps and power-transmission equipment, while also providing various oil-field maintenance services.

That puts it in a good position to profit as wells move into the production phase -- perhaps even more so as the various shale fields require specialized pressure pumping devices to tackle fracked wells' depths.

Execution at Lufkin has been so-so lately, causing its shares to sink badly. However, like Exterran, the longer-term picture for Lufkin is a bit rosier -- especially considering just how vital its equipment is to the oil and gas sector.

Shares of LUFK are currently trading for roughly $30 below their 52-week highs -- now that the momentum players have left the stock. This allows value hounds to come in scoop up shares at a more reasonable price.

As of this writing, Aaron Levitt did not own a position in any of the aforementioned securities.

More from InvestorPlace

Jan 23, 2013 12:09AM

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