June 8, 2010

Opportunity in oil spill

There has been a lot of talk of the opportunity in the energy sector as a result in the sell off of the Gulf of Mexico (GOM) producers, drillers, platform operators...etc. Most of these names have been halved in price; BP is offering 10% dividend yield, which is an amazing return by itself.

The question presenting itself, is the disaster an opportunity for stock pickers? Some think it is.

The disaster is a game changer. No one can argue that in a couple of years, and into the distant future, GOM operators will operate in the same manner as they did few years back. I do not think so. Costs are going to go up materially.

Insurance, security bonds, royalties, clean up funds, taxes...etc will be on the rise as a result of this disaster. Some suggest that platform operators like SeaHawk (HAWK), which I reviewed their spin-off and did not like, is a good value proposition as it is selling below liquidating value. However it was selling below liquidation value a year ago as well.

I think the smaller the player the more disadvantaged operationally and financially in the new and expected environment. Weak balance sheets will find it harder probably to comply with bond and clean up funds requirements and will be forced out by the bigger players, who ironically caused the disaster in the first place.

If I wanted to buy, I like McDermott International (MDR), which will spin off it is off-shore construction and management business. The company operates three businesses:
  • off shore drilling project management,
  • government operation: nuclear submarine building, and
  • fossil fuel power construction

MDR will operate the off shore construction business and the spin-off will own the other two.

My idea is to buy on the spin off date MDR as it will be more than likely added to the several energy sector ETF and mutual funds. Those funds did not own it due to the complexities of the other two units and was not pure play energy equity.
  1. MDR will be less complicated than the other unit from accounting, regulation and business is easier to understand,
  2. growth potential in offshore drilling around the world; its Arabian Gulf operations is growing at a fast clip and will offset any weakness from GOM operations,
  3. demand from energy index and sector ETFs as the company will become pure play energy service company. MDR is held in mid cap portfolios but not in sector specific ETF like energy funds; ishares Energy Service, Holders (OIH)...etc. Will the spinoff induce sector specific funds to buy the oil and gas segment to be part of energy ETF/ funds? A very high possibility.
  4. The backlog of the company alone should provide good support for earnings growth.

To capitalize on the energy sell off, I will require more odds in my favour and I think MDR might do it.