This from The Rude Awakening:

The last time I recommended T-3 Energy Services (NASDAQ:TTES) to the subscribers of my investment letter, Capital & Crisis, the stock tripled over the ensuing months. And even after I issued a “Sell” recommendation on the stock, it continued to move higher. But that was WAY back in July…and nothing is like it used to be.

From a high of $84 a share in July of this year, the stock has come all the way back down to $17. I issued a “Buy” on the stock in April of 2007, when it was selling for $21.60. We sold our final half at $63.60 — it’s now more than 70% below that price. And you know what? Not much has really changed…except the stock’s valuation. TTES is selling for about 6 times earnings now and about 5 times next year’s guess…and the company is enjoying huge macro-economic tailwinds.

T-3 makes something absolutely critical to drilling rigs. It’s called a blowout preventer (BOP). BOPs protect the crew — and preserve the rig — in the event of surges in the well. You absolutely have to them. Crews won’t work rigs without BOPs and anybody concerned about safety would never put a crew on a rig without them.

T-3 has about 15% of the market for new BOPs. If you count refurbishing older rigs, T-3 has about 30% of the market. It’s a small company, but a key player in this niche. BOPs make up about 70% of T-3’s business.

The remaining 30% includes a variety of other services for wellhead equipment and onshore pipelines. T-3’s customers are drilling contractors, exploration and production companies and pipeline companies.

Demand for T-3’s services follows drilling activity. Over the years, we’ve had to drill more and more gas wells, just to maintain current levels of production. That’s because the newer wells tend to deplete much more quickly that the old wells used to.

That trend has only continued. According to Baker Hughes, the number of working rigs rose to 1,782 at the end of 2007 to 1,906 today. As we exploit the more unconventional shale basins, which are more drilling intensive, the number of working rigs ought to keep rising.

The shale plays I’ve written about before – the Barnett, Fayetteville and in the Appalachian regions – all take a lot of drilling. Since 2001, for example, drilling in the Barnett is up nine-fold by rig count. These prolific plays now make up 12% of the total rig count according to Raymond James.

Drilling activity is what really drives T-3’s business. And energy prices dictate drilling activity. So, as the price of oil and gas has come down a bunch, the market has crushed T-3’s stock price. I think, though, that it’s been overdone. Drilling activity may slow, but we’re not rolling back to 2002 levels, which is how the market is pricing T-3.

I also especially like the rig equipment and infrastructure market. Since 2004, this market has grown 27% annually, which tops the broader oilfield services group. (The latter grew about 17% annually.) T-3 serves a good niche in this sub-market.

The company is also expanding overseas. Already 60% of the company’s sales come from overseas markets. New orders from West Africa and Russia, new subsea orders and new orders from its joint venture in the Middle East could all be catalysts for the stock price beyond just solid execution of its existing business. Earlier this year, T-3 won a contract for work in West Africa, which was the biggest single award in the company’s history. As of the last conference call, T-3 said it had $320 million in outstanding bids and 60% of that was for international markets.

Last quarter, the company reported a backlog of $81 million, a 36% increase from the prior quarter and a 31% increase from a year ago. T-3 should grow earnings at a 25% clip, yet it’s trading for 7 times earnings. You got a lot of room for error when you buy something for 7 times earnings that’s growing 25% per year.

T-3 will probably earn $40 million in free cash flow this year. Next year, the company should generate $50 million in free cash flow and earn close to $4 per share. At current prices, therefore, you’re paying less than 5 times next year’s guess for a 21% free cash flow yield. Those are bargain numbers for a healthy, growing business with little debt.

Another way to look at the stock’s value is to look at past acquisitions. Last year, acquirers paid 11 times EBITDA (earnings before interest, taxes, depreciation and amortization) for companies in this sector. Even this year, if you could pull off an acquisition at 8 times EBITDA in this sector, you were a hero. Analysts would praise you for making a good deal. Now the sector is in the toilet. T-3 trades for a bit more than 4 times EBITDA. So again, there seems to be plenty of room on the value spectrum here. The world did not change so much in the last 90 days as stock market prices seem to indicate.

Right now, multiples across the resource sector have just collapsed. If T-3 were to regain a reasonable multiple of only 10 times earnings — well below what it commanded even months ago — T-3 could be a $40 stock by next year. That’s more than double.

If we get some more juice from oil and gas prices, we could go much higher. Some of the research I’ve read on the company puts the value much higher, in the range of $72 to $90 per share. Remember, the stock hit $84 this year.  So, I think my numbers are quite reasonable. We’ve got a good shot to do a lot better than $48 per share, perhaps getting back to around $60 and tripling our money again.

I’d buy the stock up to $25 a share.

Source: Fallen Angels

The biggest change in the American economy over the last few decades has been the transition from making things to making loans. We Americans abandoned the manufacturing industries that once powered our economy and devoted ourselves to merely financial activities. We became experts in “financial origami.” Precisely when and why this happened will be something for historians to debate. But sometime in the 1990s, the percentage of corporate profits from finance surpassed that from manufacturing.

The gap between the two has only grown wider ever since. Before the recent credit crisis hit, profits from financial firms made up nearly half of total corporate profits in the U.S. Only 10% came from the manufacturing sector! As recently as the mid-1960s, these percentages were the other way around.

Eventually America’s over-reliance of financial gimmickry, rather than traditional commerce, left our economy exposed to a serious shock. The shock has arrived. But every crisis brings opportunity. In the current crisis one, investors will go back to investing in simpler, more durable things (at least until forgetfulness kicks in). The focus will shift to things we need, rather than things we want. For instance, investing in a company that supplies grains to hungry people looks like a better bet than investing in one that sells mortgages to people who can’t afford them.

To a smaller degree, we had a similar crisis in the 1970s, Kevin Phillips tells us in his new book, Bad Money. Mortgage debt doubled from 1960-70. Then the stock market crashed, losing 36% of its value from 1969-70. Hedge funds blew up. The top 28 funds lost 70% of their assets, and about 100 brokerage and financial firms disappeared – by either acquisition or outright failure. Seems a lot like the headlines of the present day, does it not?

The 1970s also had two major oil price spikes. The first in 1973-74 and the second in 1979-80. We’ve already had one oil spike now, if a second one arrives in the next few years, it could push prices through $200 a barrel.

That’s because the global oil industry has not been re-investing very actively in developing new production. America’s neglect of “making things” is very evident in the oil business. Phillips says the U.S. has a “dated, ghost-of-glories past petroleum infrastructure.” He writes that the major oil companies “are wealthy, but aging behemoths, hard-pressed to maintain production levels, despite large exploration outlays, and no longer enjoying access to overseas oil fields they once commanded.”

Exxon Mobil, once the largest oil company in the world, now ranks 25th by booked oil reserves. The top 10 are all state-owned national oil companies (NOCs). The top 13 NOCs own four-fifths of the world’s known oil reserves. They don’t share them cheaply.

A look at where we get our oil is not encouraging. Most of these sources of supply are not particularly reliable. As Phillips opines (the table below comes from his book): “Of the eight principal 2007 suppliers of petroleum to the United States as of August, only one, Canada, could be called secure and reliable.” Mexico seems secure, but exports have been falling since 2004, as Mexican production has fallen. It could become an insignificant source of oil by 2012.

And we are not alone in competing for these oil reserves. China became a net oil exporter in 1993, and its appetite grows every year. It is now the world’s second largest consumer of oil, behind only the U.S. China actually imports more oil from Saudi Arabia than the U.S. This partnership is not surprising, given the dynamics of the New Silk Road.

The “New Silk Road” is a term I use for the boom in trade between countries from the Middle East to China. In matters of energy, you see a lot of deals inked on the New Silk Road. Saudi Arabia and China get together regularly like newfound pals. Sinopec, a Chinese oil company, recently got the OK to explore the Saudis’ Empty Quarter for oil and gas. Saudi Aramco, the big oil company, put $750 million toward a huge plant in China.

Just as interesting to me is what I like to call the “New Burma Road” – after the road of World War II fame that linked China and India via Burma. The New Burma Road identifies the booming trade between India and China. As Phillips writes, “China has already made a six-lane highway out of its portion of the road from Chinese Kunming to India’s state of Assam… The demographics of a Sino-Indian entente would make it especially momentous.”

Yeah, I’d say so, given the strengthened ties between more than 2 billion people.

As you know, there is an awful lot going on in the world today, and it’s all far more complex than I can get into here. But this is where we are, in brief: The U.S. economy faces a crisis in its biggest sector – finance. The neglect of making things is finally taking its toll, a fact most apparent in the oil and gas world, but also apparent in infrastructure across the spectrum. And the world is less U.S.-centric than it has been in a long time. We see this, too, in the oil and gas sector and in the flurry of deal making along the New Silk Road (and its “momentous” segment, the New Burma Road.)

The implication of this post-finance U.S. economy is a theme we’ll explore more in this letter. As an early conclusion, though, I believe the spread between finance and manufacturing has reached millennial extremes, like a rubber band at its limits. Now begins the snap back.

Now begins the time to invest in companies that make things. Many of these companies operate in the oil services industry, and many of them are EXTREMELY cheap right now. T-3 Energy Services (Nasdaq: TTES. $16.53) and Contango Oil & Gas (NYSE: MCF. $38.50) illustrate the point. Both are “old economy” companies that provide essential products. Both are selling for less than six times earnings. I’ll provide complete details in tomorrow’s Rude Awakening.

Source: Down, But Not Out