The Best Stocks to Invest in Oil Rigs

By Markets Fool.com

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Image Source: U.S. Bureau of Land Management.

There are any ways to invest in the oil and gas space. You can go for massive companies such as ExxonMobil that have a finger in every aspect of the oil and gas value chain, or you can target one niche that has an opportunity to succeed based on how the industry is developing. One very attractive niche segment is oil rig companies, which own the big pieces of equipment used to drill.

Key attributes in these kinds of companies are wildly different from what investors would typically look for in other oil and gas companies, but when you know what is important it's actually a pretty easy sector to understand. So let's consider some things to look for when aiming to invest in oil rig companies and break down two attractive companies in the space today.

What to look for
For lack of a more eloquent way to say this, rig companies are just equipment rental companies. Their job is to keep as much of their equipment out of the stockyards and on the job as possible. So for investors, these companies' most important elements are high fleet utilization rates and and a large backlog will keep rigs working for years to come.

We are in the midst of a massive turnover of equipment. New drilling techniques such as horizontal drilling -- the other half of the equation alongside hydraulic fracturing that makes shale drilling possible -- and the need to explore even deeper waters in more exotic locales mean companies need equipment with the technology to handle these more complex jobs. Companies are updating their fleets even while they still operate large fleets of older rigs that are less capable but have contracts in place for work. This has led to today's oversupply of rigs. As older rigs come off contract, they will be challenged to secure a new contract when pitted against these newer rigs and will likely be retired. Investors should be aware of this situation.

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A couple stocks for your consideration
Seadrill
: Seadrill's biggest selling point is the quality of its assets. Almost all of its floating rigs are less than 5 years old and are capable of handling the most demanding jobs in ultra-deepwater areas. Also, a large portion of its jackup rigs are harsh-environment ready, which means they are capable of handling the cold weathers of the Arctic -- one place that holds vast potential oil reserves. Companies generally have an easier time finding work at higher dayrates for these newer, more-capable rigs. Seadrill had 94% of its rigs in use as of the latest reported quarter, along with a $17 billion backlog of work. This backlog is not necessarily set in stone, but it's a decent gauge of the industry's confidence in Seadrill's fleet.

Yes, the downturn in the oil will significantly strain Seadrill's financials, as it has taken on quite a bit of debt to finance construction of these new rigs. Also, the suspension of Seadrill's dividend was something no investor wants to see. However, the company is better positioned than many of its peers to benefit once the market swings back in the other direction, and taking the leap today could mean big rewards down the road

Helmerich & Payne: If you like Seadrill's prospects but remain wary of the financial obligations on its balance sheet, then Helmerich & Payne might be the company for you. H&P is almost exclusively an owner of U.S.-based land rigs, and it has taken an approach similar to Seadrill's in recent years. A whole new fleet of rigs is needed to take on the ever-increasing role of horizontal drilling in shale drilling. Helmerich & Payne's fleet consists nearly entirely of AC rigs, which can handle those horizontal drilling jobs.

Even more encouraging, the company didn't stretch itself at all with debt to manage this fleet turnover. Helmerich & Payne actually has more cash on hand than its total debt profile. Domestic shale drilling looks likely to suffer rather mightily from depressed oil prices, but when companies start drilling again they will likely be looking for a high-specification rig like H&P's.

What a Fool believes
The excess amount of both oil and available rigs won't be resolved overnight, but eventually it will get better. Older rigs will need to be retired, making room for newer rigs to secure contracts at more favorable rates. Companies that can keep their fleet working at a high utilization rate and build a strong backlog of work will do well as market conditions improve, so investors should look for the companies with the right assets in place today. Those with the stomach to ride out this rough patch might thank themselves later.

The article The Best Stocks to Invest in Oil Rigs originally appeared on Fool.com.

Tyler Crowe owns shares of Seadrill.You can follow him at Fool.com under the handle TMFDirtyBird, onGoogle+,or on Twitter@TylerCroweFool. The Motley Fool recommends Seadrill. The Motley Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.