Despite what any financial academic or index fund [1] advocate tells you, the market [2] isn't perfectly rational. If it were, then it would be impossible to identify a stock that is meaningfully undervalued.
There would literally be no way for an active stock picker to beat the market -- other than blind luck.
But, as I was saying... that's not the case. The market is good, but it's not perfect -- it makes mistakes.
And we should all be thankful for that. Otherwise, there'd never be any exceptional buys. You can't get ahead by paying full price all the time. And we only get to buy stocks at attractive discounts of 50% or more because the market goofs up from time to time.
That said, I think the market is making a big mistake with Patterson-UTI Energy (Nasdaq: PTEN [3]) right now. Here's the story...
Patterson-UTI is a leading provider of land-based contract drilling services. The company also assists with other critical tasks such as hydraulic fracturing and well cementing. The firm has a large fleet of 350 drilling rigs at its disposal, which are dispatched all across North America.
Demand for drilling rigs tends to rise and fall along with the peaks and valleys of oil and gas prices.
Like most of the companies in the energy drilling space, the company got hammered in 2008 when oil prices nosedived from around $150 to $40 a barrel.
The company's drilling business was essentially cut in half over that difficult stretch. The stock followed suit, plunging from a high of $37 a share to a low in the single digits.
But Patterson made a remarkable comeback in 2011. The company caters mainly to small- and medium-sized independent producers -- and those customers ramped up their drilling activity in a big way last year.
The company started the year with 194 rigs working in the field and ended with 232. Aside from the stronger fleet utilization, customers were also willing to pay higher rates. In fact, each of the firm's rigs raked in an average of $21,980 for every day on the job in the fourth quarter -- up from $19,090 a year earlier.
All told, the company boosted drilling revenue 70% in 2011, rebounding from $1.0 billion to $1.7 billion. More important, net income [4] zoomed 175% to reach $322 million, or $2.06 a share.
And there's been even more progress thus far in 2012. As of February, the active rig count has risen to 240. About half of those are locked up under long-term contracts that will throw off $1.8 billion in guaranteed future revenue. Those fixed contracts should help insulate against any temporary decline in onshore drilling rates.
Yet despite triple-digit growth rates and insulation from falling rates, PTEN shares [5] have still retreated from $34 to $18.
Much of the decline can be traced back to weak natural gas prices, which have slowed activity in places such as Louisiana's Haynesville Shale. But investors are missing the point. Customers aren't cutting back -- they're just shifting the focus from gas-directed drilling to oil-directed drilling.
The natural-gas rig count has fallen consistently for several weeks, but the oil-rig count has exploded. Back in 2009, there were fewer than 200 rigs drilling for oil in the U.S. By this time last year, that number had quadrupled to 800.
Right now, there are about 1,272 rigs working in places such as the Bakken Shale -- the highest since Baker Hughes (NYSE: BHI [6]) started tracking this statistic a quarter-century ago.
So these rigs aren't idle, they have just moved to wetter plays with better economics [7].
Risks to Consider: Of course, with investing nothing is 100% certain. Any sustained drop in oil prices could bite into exploration and production expenditures and thus drilling activity. Patterson still has many outdated rigs that will need to be retired and replaced. The regulatory environment for hydraulic fracturing is also still something of a wild card.
Action to Take --> But with shares trading close to their 52-week low [8], PTEN may be approaching its bottom. And with the company trading at just seven times earnings [9] and at a PEG [10] ratio of .30 -- now could be a good time to gain exposure to this fast-growing energy company.
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