The Marley Group

A few minutes past 12:00 this afternoon, a block trade of over 3 million shares of Bronco Drilling Company (BRNC) occurred. This single transaction alone, accounted for volume over 5 times the daily average for the past three months and represented an exchange of more than 10% of Bronco Drilling’s current market cap. Anytime a trade of such magnitude occurs, it is necessary to look into.

To my knowledge, there exists only one shareholder who could have potentially executed such a large sale, Wexford Capital LLC. While an SEC Filing wont be made until Monday, it looks as if they have unloaded their remaining stake in Bronco. Under normal conditions, such extreme selling pressure would be a cause for concern, however this was an event that has been anticipated for months. Considering this knowledge, two positives can be drawn from today’s action. Firstly, the overhead resistance that Wexford’s planned unloading has caused has been lifted. Secondly, from a technical perspective, such extreme volume as was experienced today often represents a bottom in a stock’s movement. With Wexford finally out of the way, Bronco may be ready to run.

Disclosure: Joseph Urgo has a long position in Bronco Drilling Company.

Strong Buy
12 Month Target $32.00

Last Thursday, Bronco Drilling (BRNC) reported 4th Quarter earnings per share of $0.72 excluding a non-recurring charge incurred during the quarter. We had expected Bronco to report earnings of $0.80 per share. The downside can be attributed to a drop in utilization rates to 91% in the period compared to 94% for the previous quarter and 97% in 4th Quarter 2005. Also, day rates decreased slightly from 3rd quarter levels. Despite earnings being below both internal and consensus estimates, they still displayed very strong year over year earnings and revenue growth rates in excess of 100%.

After reviewing the information provided by management in Bronco’s conference call, we now expect full year 2007 earnings per share of $2.68 and 1st Quarter 2007 earnings of $0.54. The downward revision can be attributed to management calling for a Q1 utilization rate in the low to mid 80s. Management is looking for utilization rates to stabilize in the 2nd Quarter and eventually return to previously attained levels. Supply of rigs has increased in recent quarters while demand has dropped slightly, both negatively effecting Bronco’s prospects in the short term. They have continued their refurbishment program and intend to do so until commencing it at the end of the 1st Quarter. By that time, Bronco should have 54 rigs in opertation, compared to an average of 50 operating rigs in Q4 2006.

Management placed much of the emphasis of the conference call on their newly acquired well services division. The well services industry is expected to grow at a faster rate than the well drilling industry, as the unusually high growth rate in operating drilling rigs experienced in the past few years will result in increased demand for services on these wells in the near future. Earnings in the divison are also less subject to swings caused by moves in the energy markets, the well services industry is less cyclical than the well drilling indurty. They are looking to further grow their presence in this field, possibly by acquisition with excess cash flows once the refurbishment program is suspended at the end of Q1. If no attractive acquisitions surface, the excess cash will be used to retire outstanding debt, shoring up the balance sheet.

While the conference call should be viewed as a net negative event, with management anticipating a sizable decline in utilization rates in the current quarter before eventually stabilizing and firming up later in the year, the positive commentary on their well services’ operations is encouraging. Also, I view Bronco’s decision to suspend their refurbishment program as a positive, as current industry conditions make growing their well services division by acquisition or cleaning up their balance sheet a more sensible way to invest capital provided by operations for the time being.

Given our new view of full year 2007 earnings per sare of $2.68, and maintaining our view of shares being worthy of carrying a P/E of 12, we our lowering our 12 month price target to $32.00. However, despite the lowered price target, I am maintaining my belief that shares of Bronco Drilling represent significant value at these values, therefore maintaining a strong buy rating on Bronco Drilling Company. In the short term, continued selling pressure may prevent shares from appreciating too much as Wexford Capital, former private owner of Bronco Drilling and now large shareholder who has been unloading shares for some time now, continues to sell off their stake in the company. Also, a now expected weak Quarter 1 may hold back shares in the short run as well. However, if rates stabilize and improve in the later part of the year, as management has siad they anticipate, Bronco will be well prepared with 54 operating rigs and a well services division. Even with a weak 1st Quarter expected, their comparable year over year growth rates should still be impressive with earnings per share gains of over 20%, deserving of a P/E multiple of at least 12. Currently trading at a trailing P/E of 6.3, Bronco remains attractively valued at current levels.

Disclosure: Joseph Urgo has a long position in Bronco Drilling Company.

A little more than a month ago, The Marley Group initiated coverage on Bronco Drilling Company (BRNC) with a strong buy rating. After initially rising following our recommendation, shares have since fallen to new all-time lows, closing today at $13.61.

The recent slump in shares is the result of irrational trading decisions in my opinion. There has been no major company related news, the only recent event was a small acquisition that was greeted as a non-event in the trading day following its announcement. Natural gas has come down since the time of our recommendation, however it has not dropped to levels that would warrant a 20% drop in market value over the course of a few weeks. Assuming the absence of some sort of catastrophic event that has been driving the trading of the past few weeks whilst unbeknown to the general public, this move can only be rationally viewed as an opportunity to accumulate at an even more favorable risk to reward ratio.

Bronco Drilling Company currently has a book value of $12.95 per share. This means that the market is currently valuing Bronco’s business operations at less than $0.67 per share, $0.10 less than they should earn in the current quarter alone. If shares of Bronco Drilling slide much further, the company will be selling for less than their rigs alone are valued at. If this happens, some one could theoretically acquire all of the outstanding shares of the company, disband all operations and sell the rigs, and record a sizable arbitrary capital gain. This makes the possibility of any further downside in Bronco shares very limited. I reiterate strong buy rating on Bronco Drilling Company and stand by my previous predictions. The fundamental picture remains very strong and in due time will drive a significant appreciation in the value of this company.

Disclosure: Joseph Urgo has a long position in Bronco Drilling Company.

Strong Buy
12 Month Target $42.00

Every so often, a tremendous growth stock can be accumulated at prices attractive to a value investor. These companies make for some of the best investments. Bronco Drilling (BRNC) is one of those companies.

Bronco Drilling Company provides contract land drilling services to oil and natural gas exploration and production companies. They own a fleet of 64 land drilling rigs, of which 50 are currently operating, 4 are in the process of being refurbished and 10 are held in inventory.

By many common valuation metrics, Bronco is very cheap. They are trading at a trailing P/E of 8.5 and a forward P/E of only 5.73, based on today’s closing price of $17.70. The current price/ book value ratio for Bronco is only 1.37. They are trading at a trailing P/EBITDA of 4.

Ratios as low as these would catch the eye of most any value investor. A company trading at these ratios would normally be a mature or even deteriorating business. Bronco Drilling is far from being either of these. In the past 12 months, they reported revenue of $242.3 million, a more than 500% year over year improvement on the $47.6 million they reported in the prior 12 month period. Earnings have grown at a similar clip. Earnings per share for FY 2006 are expected to come in at $2.54. Analysts are also looking for $3.09 in earnings per share for FY 2007. Yahoo! Finance shows Bronco as having a PEG ratio of 0.13, an extremely low figure.

We believe Bronco is well positioned to beat these current estimates to the upside, something this company has consistently done since their IPO a little more than a year ago. Based on management’s expectations of ending Q1 2007 with 55 rigs in operation (compared to 50 at the end of the most recent quarter), and assuming day rates increase at a rate consistent with historical increases, Bronco’s earnings should increase by at least $0.10 per share to $0.80, above analysts current estimates for the quarter of $0.79. This $0.10 improvement is based solely on a 10% increase in operating rigs and modest increases in day rates, something that management expects pointing out that three contracts that will be renewed in the current quarter will be renewed at higher daily rates. As the rig refurbishing program slows, spending will as well, giving further potential upside to the aforementioned $0.10 improvement. Given this knowledge we are looking for Bronco to earn $0.82 per share in Q1 2007 and $3.52 for FY 2007.

The shares of most companies throughout the Oil and Gas Exploration Services industry have had a rough year, following a decline in natural gas prices. The fear of further declines in natural gas prices is overdone in our opinion, and expectations of a warm winter are already factored into current natural gas futures prices. We feel this overreaction to the year’s declines in natural gas prices is evidenced by the fact that companies throughout the industry are trading at steep discounts to historical prices based on current P/E and P/EBITDA ratios. A reversion to the mean is anticipated therefore we are looking for P/E ratios to expand throughout the industry. Bronco currently trades at a trailing P/E of 8.5, we view a P/E of 10 as fair value for a company in Bronco’s sector. Given Bronco’s strong growth rates, they deserve to trade at a slight premium to their peers, making a P/E of 12 justifiable for this company. By applying this multiple to our estimate of FY 2007 earnings of $3.52, we arrive at a fair value of $42.00 for shares of Bronco Drilling Company. Also supporting our Strong Buy recommendation is a downside limited by their very low Price/ Book Value ratio relative to their peers and their strong balance sheet. A strong technical base was recently built at $17.00, a figure that we view as a bottom in Bronco’s share price. Bronco Drilling represents one of the markets most compelling investments based on our perceived risk to reward ratios.

Disclosure: Joseph Urgo has a long position in Bronco Drilling Company.