There's value in the 'picks and shovels' sector of equipment and services.
You've probably noticed that the shares of oil majors BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) have been cheap for some time. By 'cheap', I mean they have low P/E ratios -- 7.5 and 8.5 respectively.
However, in both cases, earnings are expected to fall significantly in the current year and analysts are forecasting only modest growth for 2013.
So, BP and Shell's low P/Es might be said to be justified -- even if many long-term investors are happy to accept the quite tasty dividends (forward yields of around 5%) while waiting for earnings to grow again.
It's a different story for the 'picks and shovels' companies of the oil and gas industry -- firms that aren't directly involved at the dirty end of the business but which provide the vital equipment and services the industry needs.
As you can see in the table below, the FTSE's five biggest equipment and services companies are on higher P/Es than the oil majors. But crucially for valuations, strong earnings growth is also forecast.
As such, on a P/E to earnings growth (PEG) valuation -- where a PEG ratio of less than 1 indicates growth at a reasonable price -- the equipment and services companies actually look better value than BP and Shell right now.
|Company||Market cap (£bn)||Share price (p)||P/E||Earnings growth (%)||PEG||Dividend yield (%)|
|Petrofac (LSE: PFC)||5.5||1,589||12.3||16||0.8||2.7|
|Amec (LSE: AMEC)||3.8||1,163||13.2||16||0.8||3.2|
|Wood Group (John) (LSE: WG)||3.1||827||13.9||25||0.6||1.6|
|Hunting (LSE: HTG)||1.2||799||12.6||29||0.4||2.5|
|Kentz (LSE: KENZ)||0.4||359||9.1||14||0.7||2.7|
Figures based on rolling 12-month forecasts
You may not get much of a dividend from these companies -- Amec's yield of 3.2% is as good as it gets -- but what you can expect is robust earnings growth relative to the P/E rating.
While it's true you could have picked up shares in these companies cheaper than they are today during the market slump of May/June, they still look decent value on a PEG basis, despite some strong rebounds in their share prices.
Let's have a closer look at them.
The biggest of the five companies – ranked 60 in the elite FTSE 100 (UKX) index – oilfield services company Petrofac was established in 1981 when it employed just 25 people. The company has grown rapidly and now has some 16,500 staff worldwide.
In the last five years alone, Petrofac has increased its earnings three-fold. This year, revenue is expected to break through the $6 billion mark for the first time, and the company is bullish on profit growth.
In a trading update in June, ahead of half-year results scheduled for this coming Monday, Petrofac said it was "on course to deliver net profit growth in 2012 of at least 15%."
For a company with Petrofac's track record, a PEG ratio of 0.8 looks pretty appealing. Estimated net cash of $700 million on the balance sheet at 30 June adds to the attraction.
Another FTSE 100 company, Amec, which provides consultancy, engineering and project management services, is a little more diversified than Petrofac. Amec supplies the mining, clean-energy and infrastructure markets in addition to the oil and gas industry.
Amec started life as a humble UK-based construction firm in 1848, but today operates globally with 27,000 employees serving some of the world's biggest organisations, including BP and Shell.
Amec has half-year results scheduled for tomorrow (Thursday). In April, the company reported it had performed in line with expectations during the first three months of the year. Amec added it was continuing to see healthy demand for its services and was "confident that this will support double-digit underlying revenue growth in 2012."
Like Petrofac, Amec has a PEG ratio of 0.8 and a strong balance sheet. At 31 December 2011, net cash stood at £521 million and the directors earmarked £400 million for share buybacks in 2012.
Wood, Hunting and Kentz
These three firms are all listed in the FTSE 250. They have somewhat more attractive PEG ratios than their FTSE 100 peers.
The PEGs in the case of Wood (0.6) and Hunting (0.4) are premised on very strong forecast earnings growth of 25% and 29% respectively. In the case of Kentz (0.7), the smallest of the companies, the PEG arises as a result of a lower P/E and relatively modest earnings growth of 14%.
I particularly like Hunting – indeed, to the extent that I've owned shares in the firm for several years. Hunting provides equipment and services to oil and gas operators in the areas of well construction, well completion and well intervention.
I wrote bullishly about Hunting back in March, when the shares were trading above their current level. Today, they are on a very attractive PEG of 0.4 and I expect the company to deliver on the forecast earnings growth.
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> G A Chester owns shares in Hunting.