Pays to Have Mixed Equity

In September of last year, I wrote about the dilemma in the oil and gas business and a great company in which to invest. Even though oil and natural gas prices are still high, they are well down from previous spot prices and company stock prices have followed suit.

But here’s the thing… even if the bull market in oil and gas stocks is over, most of the companies in the industry are still awash in cash. So, what are they going to do with all this cash over the coming years?

Well, they really only have two options. They can increase their dividends paid to stockholders, or they can increase their capital expenditures to find more of the black gold.

From the investor’s standpoint, you have to ask yourself who benefits when oil and gas companies spend money on development. The answer is simple–oil and gas service companies.

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Back then, I wrote about Allis-Chalmers Energy Inc. (AMEX/ALY) as one of the most attractive service companies in the industry. Based in Houston, the company sells specialized equipment to install casing and production tubing required to drill and complete oil and gas wells. Other services include directional and horizontal drilling, compressed air drilling, and the rental of specialized tools. The company recently joined the Russell 2000 small-cap index.

In its latest quarter, the third quarter of 2006, the company generated record revenues of $85.7 million, representing growth of 197% over comparable revenues of $28.9 million generated in the third quarter of 2005. Most of the increase in revenues was due to acquisitions, but a good portion was due to organic growth.

Net income for the third quarter of 2006 grew a whopping 770% to $11.3 million, or $0.50 per diluted share, as compared to net income of $1.3 million, or $0.08 per diluted share, in the third quarter of 2005.

Back in September, this stock was trading around the $15 per share mark. Now, it’s trading around $22 per share.

Going forward, Allis-Chalmers Energy plans to make more acquisitions, hoping to grow its revenue base to over $470 million in fiscal 2007, up from about $300 million this fiscal year.

At the end of the day, I think it really pays to have a mixed equity portfolio of great companies. In this case, despite weakening spot prices for oil and gas, Allis-Chalmers Energy serves to illustrate how a related industry can flourish with these fundamentals.