Play the Energy Patch With This Mid-Cap Value Pick
The market has yet to recognize the value of the oil & gas driller's recently announced $2 billion acquisition. Here's how to trade it.
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My next covered call trade idea is a play from the energy patch, a sector that has underperformed recently despite the escalating tensions in the Middle East.
Helmerich & Payne HP is a Tulsa, Oklahoma-based provider of drilling rigs and services that has been around for more than a century. It has primarily been focused on the North American on shore oil and gas exploration industry. But that is about to change in a significant way due to an acquisition the company announced in late July.
Helmerich & Payne is purchasing KCA Deutag, a Mideast land drilling and offshore contract services provider, for cash consideration of just under $2 billion in a deal that should close by late this year. This will add 83 onshore rigs, 63 of which are situated in Saudi Arabia, Oman, and Kuwait, as well as the management of 29 offshore platforms located in the North Sea, Canada, Azerbaijan, and Angola. It will also leave Helmerich & Payne with the largest onshore rig fleet in the world outside of China when the deal closes.
Thje company is paying a very reasonable 5.4x EBITDA for this acquisition. It will also acquire a $5.5 billion order backlog, which consists of $3.8 billion of firm commitments with $1.7 billion worth of buying options. To put in perspective, Helmerich & Payne’s order backlog before this deal was approximately $1.5 billion.
The acquisition will increase the leverage on the company’s balance sheet to 1.7. However, with substantial free cash flow, management is confident it can get this down back to 1x within two years. Towards that effort, the company will suspend its supplemental dividend in 2025 but will still pay out its regular quarterly dividend of 25 cents a share. This gives the stock around a dividend yield of nearly 3%.
The current analyst consensus has the company delivering earnings of $3.55 per share in fiscal year 2024. That leaves the stock trading at just over 10 times forward earnings with a solid dividend yield and a much-expanded order backlog once the KCA Deutag acquisition closes. In my view, that's more-than-decent value in an overbought market and one I can enhance via covered call orders.
Option Strategy
Here is how one can initiate a position in HP utilizing a covered call strategy. Remember, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Selecting the March $35 call strikes, fashion a covered call order with a net debit in the $31.60 to $31.70 a share range (net stock price - option premium). Liquidity is good with the options against this equity.
This strategy provides downside protection of 13% over the trade’s duration, which includes two quarterly dividend payouts of 25 cents a share. This strategy also provides return potential of approximately 12%, including dividends, even if the stock trades slightly down over its five-month trading duration.
At the time of publication, Jensen was long HP.
