3 Best Stocks to Watch in Oilfield Services

By Markets Fool.com

The oil-price crash has hit all oil stocks hard, but it also offers long-term investors a great chance to buy some of the best oil-service stocks, such as Halliburton , Schlumberger , and Core Laboratories , at a discount. There are three reasons these stocks are set up for market-beating total returns over the coming years: the long-term growth in oil and gas spending, competitive advantages that results in industry-leading profitability, and strong balance sheets that allow them to thrive during inevitable industry downturns.

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Let's take a closer look.

Oil and Gas industry spending set to explode in coming decades

Source: EIA

As this chart shows oil and gas will retain a dominant role in the world energy mix for several more decades. In fact ExxonMobil expects oil and gas to provide about 60% of world energy in 2040.

Thanks to an expected 14 million barrels per day increase in oil demand over the next 25 years, the International Energy Agency predicts that $22.5 trillion-- or $900 billion per year--will need to be invested into additional oil production by 2040. Given the immense size and scale of Halliburton and Schlumberger, and their ability to operate in every aspect of oil and gas production, I think it's safe to say that a large amount of this cash will flow their way.

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Similarly, Core Labs industry leading technological edge in reservoir mapping, analysis, and optimization methods should provide many more years of strong sales, earnings, and free cash flow growth to its investors.

Solid profitability that's only set to get better
Thanks to their competitive advantages, large economies of scale for Halliburton and Schlumberger, and in the case of Core Labs, its technological expertise, all three oil service companies are highly profitable and are also excellent at generating good returns from shareholder equity, assets, and invested capital.

In fact oil downturns are really a long-term opportunity for these companies to grow larger and more profitable over time.

Halliburton's $34.6 billion buyout of rivalBaker Hughes is a perfect example ofhow the large scale and resources of the industry's dominant players can use an oil crash to their advantage by acquiring competitors andthus increasing global market share and pricing power once oil prices recover. Then there's the opportunity for billions in synergistic cost savings that such mergers can create. In fact this tactic is one that both Halliburton and Schlumberger have used in previous oil downturns in order to become the two largest oil service providers in the world, and some of the most profitable.

Large scale doesn't necessarily mean an inability to react quickly to changing market conditions, however. For example, despite falling earnings, Schlumberger believes it can continue to generate strong free cash flows -- which allows for buybacks of undervalued shares and protects the dividend -- by slashing its capital expenditures and capital requirements in line with the decline in oil-service demand.

Core Labs' impressive profitability is likely to suffer a bit in the short-term during any industry downturn. However, the extremely high value added services it supplies -- that allow oil and gas producers to maximize oil well profitability -- do not represent the lowest hanging cost savings fruit that oil producers are likely to cut back on.

For example, the company uses technology like CT scanners and advanced drilling fluid analysis to tell an oil company how big their field is, what kind of oil they have -- important because different grades of crude sell for different prices and are refined into different end products -- and where, and how to drill to maximize production, and profitability.

Solid balance sheets provide flexibility during industry downturns
All three companies have strong balance sheets with low leverage ratios and extremely manageable annual interest costs.

This provides not only the flexibility to survive this and future oil crashes but also allows for strategic opportunities to increase shareholder value by either acquiring competitors -- to improve market share and improve margins via synergistic cost savings -- or grow future free cash flow per share through share buybacks as Core Labs has been aggressively doing for many years.

CLB Shares Outstanding Chart
CLB Shares Outstanding data by YCharts

Bottom line: These oil-service gems are likely to thrive despiteoccasionalindustry downturns
Oil prices are volatile and unpredictable, so no one can accurately predict when the oil-service industry will finally bottom out. However, given the long-term trends in global oil and gas demand growth its fair to say that all three companies' services will be in extremely high demand in the coming decades whichpresents an opportunity for long-term investors. By snapping up shares of world-class oil-service stocks such as Halliburton, Schlumberger, and Core Labs during an industry downturn when they're still undervalued, you can set up your diversified income portfolio for potential market-beating total returns in the years ahead.

The article 3 Best Stocks to Watch in Oilfield Services originally appeared on Fool.com.

Adam Galashas no position in any stocks mentioned, however, he does leadThe Grand Adventuredividend project, which recommends Halliburton and Core Laboratories.The Motley Fool recommends Core Laboratories and Halliburton. The Motley Fool owns shares of Core Laboratories and Halliburton. 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.