By Thomas Streater
There has been no shelter from the storm ripping through the oil
industry. From the smallest exploration company to industry
behemoths like ExxonMobil, the slumping oil price has weighed
heavily on energy stocks.
A surfeit of oil sloshing around global markets thanks to the
U.S. shale revolution has prompted investors to jettison stocks
exposed to what many believe will be a prolonged period of weaker
crude prices. But the seemingly indiscriminate selling is providing
some interesting opportunities for investors with longer term
horizons and a stomach for risk. One of those opportunities is Hong
Kong-listed oil services group Hilong Holdings ( 1623.HK ).
Since its IPO in 2011, Hilong's share price has slumped, soared
and slumped again.
The stock had fetched around HKD7 a share last January, but has
tumbled to its current HKD1.87 a share amid concerns about its
exposure to big oil companies as they cut their capital expenditure
as the crude prices plumb five-year lows. The selloff appears
overdone, especially given the company's expansion of its business
into more value added and higher margin services and products.
Hilong is one of the better plays in China's fledgling oil
services and equipment sector. The company has four key businesses:
drill pipes, coating materials and services, oilfield services and
offshore engineering. The company started life in 2001 in pipe
coating -- which helps prevent corrosion of pipes -- and has become
the largest supplier of coating materials and services with a
market share in excess of 60%. The business enjoys high entry
barriers given the need for ongoing research and development
spending. According to Bernstein, Hilong doesn't file patent
protection for fear of disclosing its secrets to rivals.
The company's drill pipe manufacturing business is expected to
grow over coming years. Hilong endured weaker revenues from this
business in 2013 amid delays in U.S. sales and reduced demand from
Chinese oil companies. However, international sales have recovered
in 2014, and given the need for drill pipes to be replaced every
one to three years, domestic demand is expected to pick up next
year. The necessity of pipe replacement means this part of the
business is well positioned regardless of how much oil companies
cut their spending. Additionally, Hilong is seeking to move away
from a reliance on commoditized drill pipe manufacturing by
offering tailor-made pipes, a business that offers higher
margins.
Hilong is also growing its oilfield services beyond China's
borders. The company is still a small player in the internationally
competitive industry with just 13 rigs, but revenues grew at about
50% a year between 2010 and 2013. The company operates in Ecuador,
Nigeria, Pakistan and Kazakhstan. Crucially, Hilong has built a
solid operational track record which should allow it to win
business from major clients like Shell and Schlumberger. Royal
Dutch Shell (RDS/B) has repeatedly re-contracted Hilong drilling
services. The company has provided contract drilling services for
Schlumberger (SLB) in Nigeria since 2011. With its lengthening
track record Hilong is building the foundation to challenge the
industry's bigger players for work.
Hilong has also established a new offshore engineering services
business, with the recent acquisition of a special barge for
offshore pipe-laying. The barge can be used to lay 'concrete
weighted coating' pipes to fix pipelines to the seabed. The company
already provides CWC pipes, so the acquisition of the barge allows
it to promote an integrated service in negotiations with
clients.
Hilong is clearly focused on moving up the value chain into
higher margin services and products, while also expanding its
international business with key clients. PetroChina (857.HK)(PTR)
and Sinopec (386.HK)(SNP) are still the company's major customers
and Hilong expects a gradual recovery in its China operations next
year. However, international markets accounted for 50% of revenue
in 2013. Hilong acquired Texas Internal Pipe Coating LLC this year,
with the deal providing it with a presence in the largest oil
producing state in the U.S.
The punishment meted out on Hilong's share price has made its
valuation more compelling. The market appears to underappreciate
the company's growth prospects, with the stocks trading at 5.3
times projected 2015 earnings. That is cheaper than China's major
oil services company China Oilfield Services (2883.HK) which trades
at 6.6 times, and independent rival Anton Oilfield Services'
(3337.HK) which fetches 14.3 times. The average of the global major
players of Schlumberger, Halliburton (HAL), Baker Hughes (BHI) and
Weatherford International (WFT) stands at 14 times, which
highlights the potential rerating Hilong could enjoy if it is able
to build on its moves into international markets and higher margin
products and services.
The Chinese symbol for danger is a combination of the symbols
for crisis and opportunity. The stock might look dangerous, and the
sector has indeed been going through a crisis, but in holding
Hilong Holding's stock, there is great opportunity.
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Email: thomas.streater@barrons.com
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