Whatever An Oil Rig Needs, National Oilwell Stocks It

New oil rigs are popping out of the ground and water in or off Norway, Russia, West Africa, Brazil, the Gulf of Mexico and lots of other regions.

It's like the perfect storm. While demand for oil has been growing, new supply hasn't kept pace. To find new reserves to expand supply, you need to drill for more oil.

For several years, the number of rigs had been dropping. In the U.S. alone, the rig count dipped from 5,000 in the early 1980s to less than 2,000 recently. Many are more than 20 years old.

Add in another factor: Oil prices are high enough to make capital investments in new rigs worthwhile.

Enter the 800-pound gorilla, National Oilwell Varco, the largest worldwide supplier of drilling gear and services in the industry. National NOV sells almost everything, if not all, that goes on a rig, from mud pumps to riser systems.

"Just about everybody out there in the oil field is our customer," said Chief Executive Pete Miller. "We sell to Exxon (Mobil) XOM, drilling contractors, other service companies."

National's main rival used to be Varco International -- until the two merged in March 2005. During the prolonged slowdown, they had been buying up other rig suppliers -- more than 140 since 1996.

"We saw what was coming and we were able to ride out the rough spots," Miller said. The buying spree left fewer suppliers standing. Those remaining are smaller and don't sell such a broad array of products as National.

"There is not one big company out there that is the challenger to National," said Joe Agular, an analyst with Johnson Rice. And now that the rig cycle is in an upswing, "its dominant position is paying off," he said.

Market Share

Credit Suisse estimates that National holds down about 50% market share. With Varco on its team, National's 2006 revenue leapt 42% from 2005 to $7 billion.

The rig-replacement cycle began about two years ago. The worldwide rig count in March totaled 3,135, up from 3,069 in March 2006, though down 217 from February, according to Baker Hughes.

"We're in the early stages of a drilling upswing," said Agular. He expects the cycle to last another two or three years.

The fastest-growing part of National's business now comes from overseas. International rig growth "plays to the strength of this company," Miller said. "We have 27,000 employees and half are outside the U.S. So we are uniquely able to take advantage of the international rig market."

Orders from overseas make up 75% of the company's equipment backlog and nearly half of its services backlog. In the fourth quarter of 2006, only 45% of revenue came from outside North America.

The number of overall rigs working outside North America in March jumped 11% from the prior March to 994, the highest number in 18 years. It was the fourth consecutive month of positive overseas growth.

Bear Stearns analyst Robin Shoemaker expects the international rig count to grow another 6% by year-end. The fastest-growing regions over the last year have been in Latin America, the Middle East and Africa, he wrote in a research note.

International expansion is generally driven by oil prices and the search for oil, while North American rig expansion is driven more by gas.

Sharp rig drops in Canada in March caused North American rig counts to decline modestly from a year ago. But the U.S. rig count was up 13% from a year ago. A couple of regional natural gas plays are expected to continue to fuel drill growth in the U.S.

The Canadian slump was caused in part by seasonality and a slowdown in shallow gas and coalbed methane drilling, wrote Shoemaker. Natural gas storage levels had been high, though that's lessening, he wrote.

Rig expansion is especially active in deep offshore water, where oil firms are increasingly on the prowl.

More Gear

That means bigger orders for National. Deep-water rigs cost much more than rigs in shallow water or on land. They need more gear.

For a deep-water drill that can cost as much as $600 million, National could be expected to take in $250 million in orders, spread over a few years.

Miller says future exploration will be geared to deep-water reserves.

As the returns on investment for new rigs have gone up, so have the prices for rig products and services. Credit Suisse estimates that National upped the price of major rig parts by at least 20% since the latter part of 2005.

Improved manufacturing processes at National helped boost margins, analysts say. Fourth-quarter operating margins rose to 20%, from 12.5% the year earlier.

National's earnings in 2006 jumped 96% from 2005 to $3.90 a share.

Analysts polled by Thomson Financial see more good times ahead. They estimate first-quarter earnings will rise 87% to $1.33. They see them going up 41% for the year and 16% next year.