Our Underperform recommendation for Nabors Industries (NBR) reflects our bearish view of the North American land-drilling scene, which accounts for more than two-thirds of the company’s total contract drilling earnings. The drop-off in drilling activities in response to the combination of commodity-price weakness and credit market tightness is weighing on the fortunes of all oilfield service players in general and land drillers (such as Nabors) in particular.
The company did manage to post better-than-expected second-quarter earnings (topping the Zacks Consensus Estimate by 4 cents) on the back of stronger margins associated with new rig deployments in its international operations and solid performance from the Alaska sub-segment. However, results were significantly below year-earlier levels, reflecting a sustained slowdown in North American activity levels.
We remain concerned about the North American land-drilling scene and its impact on Nabors, the largest onshore driller. This, coupled with the company’s relatively weak balance sheet (net debt-to-capitalization ratio of around 46%) in an environment of continued credit market turmoil, accounts for our grim outlook.
While the current U.S. land rig count is already down more than 52% from its all-time peak in August 2008, we see significant room for further decline in the coming months before the market stabilizes. This idled drilling capacity will continue to weigh on dayrates and margins into 2010, even as natural gas’ outlook improves towards the end of 2009, in our view.
In order to offset the relatively soft U.S. drilling scene, the company is looking more and more towards international growth opportunities. After spending around $1.5 billion in 2008, management is guiding towards capital investment of approximately $1.1 billion in 2009. This may be significantly burdensome for the company’s future cash flows and stretch its balance sheet.
Given these headwinds, we expect Nabors shares to be under pressure in the medium- to long-term until fundamentals in the land-drilling market improve meaningfully.
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