Three Energy Plays to Tap

With crude prices above $80 a barrel, you might be tempted to invest in oil companies. But the shares of companies that serve them offer more potential.

That's because producers haven't invested enough over the past two decades for exploration and development of new oil deposits. So now they have to pony up to the companies that supply the rigs, manpower and technology that help discover and extract oil.

Thanks to steadily rising oil prices, energy-services stocks have soared, on average, an annualized 51% over the past five years,

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Investors should "keep it oily and international" when looking for stocks of energy-services companies, says Sean Kraus, an energy analyst and portfolio manager with Provident Investment Counsel, a Pasadena, Cal., institutional investment firm. Why? Because service companies should see faster growth in business for oil exploration, particularly for overseas and offshore projects, than for new natural gas deposits, Kraus says.

Schlumberger, the world's largest oil-services company, fits that mold perfectly. For the past five years, the Houston-based company has bolstered its operations in Asia and the Middle East. Its affiliations with overseas universities have helped the company develop a technological edge, especially in deep-water drilling. And its efforts to recruit locals in the countries where it does business has made Schlumberger an industry leader, says UBS energy analyst David Anderson. The result is that Schlumberger has an unmatched global footprint, with more than $2.8 billion in the treasury.

Because of Schlumberger's leadership position, the stock usually commands a higher valuation than the typical energy-service company. Analysts estimate that Schlumberger (symbol SLB) will earn $4.17 per share in 2007 and $5.10 next year. At its September 21 price of $106.20 (down 1% for the day), the stock trades at 21 times 2008 estimates.

An above-average P/E ratio is appropriate, Kraus says. "We can see 20% growth in earnings for the next four to five years," he says. Anderson rates the stock a "buy" and has a 12-month target price of $121.

When you hear the name Halliburton, you may think "no-bid contracts." But Halliburton, also based in Houston, has shed its KBR division, which provides construction services and works with the U.S. military in Afghanistan and Iraq. "The seas have calmed, and Halliburton has emerged as a strong pure-play in the oil services industry," Anderson says.

Some doubters say Halliburton isn't as attractive as other companies because it relies too much on slower-growing North America (about half of its annual revenues of $24 billion are generated there). But Anderson says Halliburton is making inroads in the Middle East and should see increasing business in Latin America.

Halliburton has plenty of cash -- $2.2 billion as June 30 -- to help it grow overseas through acquisitions. So far this year, it has bought Russian firm OOO Burservice and PSL Energy Services, which has operations in Europe, the Middle East and Asia.

The stock (HAL) gained 1.56% on September 21 to close at $38.95 and is up 30% year to date. It trades at 13 times the $2.98 per share analysts expect the company to earn in 2008. Anderson rates the stock a "buy" and thinks the shares are worth $52.

FMC Technologies, much smaller and less-well-known than Schlumberger and Halliburton, dominates a valuable niche in offshore drilling. The company has about 40% of the market for equipment known as subsea trees, which are assemblies of valves, spools and fittings for underwater oil wells.

The complexity of this equipment has increased as drillers search in deeper waters. "The economics of subsea development far outstrip those of surface facilities and will only continue to gain share as technology advances," says Robert MacKenzie, an analyst with investment bank Friedman Billings Ramsey.

The stock (FTI) has appreciated 428% since its June 2001 initial public offering. It closed at $56.74 on September 21, up 2%, and trades at 21 times the $2.65 per share analyst expect the company to earn in 2008. MacKenzie rates the stock "outperform" and thinks the shares are worth $77. "The company's brilliant growth prospects remain underappreciated by the market," he says.

Yes, the sector is notoriously volatile. Energy-services stocks typically suffer 10% drops four or five times in a year. Nevertheless, strong economic growth overseas, especially in developing markets, should fuel demand for oil and natural gas for years to come. That means more spending on exploration and drilling.