We have downgraded onshore contract driller Patterson-UTI Energy Inc. (PTEN) to Neutral from Outperform following the stock’s recent gains, which have brought its valuation in line with our earlier expectations.

Patterson-UTI is one of the largest onshore contract drillers in the U.S. with approximately 350 land-based rigs that operate primarily in the oil and natural gas producing regions of North America. Additionally, the company is engaged in the exploration and production business and provides pressure pumping services.

In the most recent earnings release, management indicated that U.S. drilling activity is picking up, reflected by the sequential improvement in rig count. Patterson-UTI also stated that there is considerable tightness in the market for shale-suitable rigs, and dayrates across the rig fleet have been going up. In the near term, the company stands to benefit from the current boom in pressure pumping services.

While we continue to like the company for its growing premium land rig fleet, stellar financial health (free cash flow positive and a debt-free balance sheet) and exposure to the boom in pressure pumping services, we think that the current valuation is fair and adequately reflects the company’s future growth prospects.

Patterson-UTI – which competes with other U.S. onshore drilling companies, including Nabors Industries Ltd (NBR) – also faces weak natural gas fundamentals, which are expected to further limit its ability to generate positive earnings surprises.

As such, we expect Patterson-UTI’s growth potential to be restrained with little room for meaningful upside from current levels. Our long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating).

 
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