What's Driving Precision Drilling Trust Into the Ground? 11 comments
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Is there anyone out there who could explain how under normal efficient market conditions a very profitable company could trade at 60% of its tangible book value? And by profitable, I mean very, very profitable. For the first 9 months of 2008, Precision Drilling Trust (PDS) reported net GAAP income of $1.67/trust unit, with last quarter's earnings beating average analyst expectations by more than 8%. Expectations for Q4 are another 64 cents/unit. With PDS trading at $6.33/unit, the price at which I bought them shortly before Thursday's market close, that works out to an estimated 2008 PE of under 2.75!
Amazing, you would think, but that's far from the whole story, of course. And as is most often the case with equities trading at deep discounts to their peers, there are many important facts hiding behind the surface. Why these facts didn't dissuade me from buying PDS is yet another question, which I will attempt to answer here shortly.
I'll start by telling you what PDS is, was and plans to be. PDS currently provides contract drilling, completion and production services to oil and natural gas companies in Canada (mostly) and the United States. This one very agile company has Canadian roots going back to the early 1950s. By 2004, this trust's predecessor company had grown to include operations virtually world-wide and then by the end of 2005, the company divested all its non-Canadian operations and converted to a unit trust income structure for tax reasons. Expansion outside Canada started again the following year with a rig in Texas.
By the end of Q308, PDS had expanded its US operation to 28 rigs and its Canadian drilling fleet stood at 220 rigs, with operating days up 14% from last year. Yes, you read that right, up 14% from last year and BTW and at that time PDS units where trading at about 3x their current price. In fact, I first bought these same PDS shares at $17.91 just over a year ago and sold them for a whopping $23.51 at the end of March this year. At one point in 2006, these units even traded at over $38. But that's all history. What I want to know is how much these units are worth today, in today's tough economic environment and with prices of oil having come down by over a factor of three from their peak. I also want to know where this company is going in the future.
Let's look into the crystal ball first. On December 23, PDS is expected to complete its acquisition of Grey Wolf, Inc. (GW) - a US based drilling competitor. When this deal was first announced on August 25, the world was quite a different place and paying $5 plus 0.188 PDS shares per share of GW, a competitor with a decent footprint in the US, may have looked quite reasonable. On the date of the announcement, PDS closed at $20.18 and GW at $8.48. At those values, PDS was paying an equivalent of $8.79 a share, or a mere less than 4% premium. Borrowing costs were still reasonable for viable businesses like PDS and PDS was expecting to be able to borrow the money needed for this transaction at 8%.
However, times have changed… Grey Wolf shareholders are actually getting a very sweet deal at this point - a blended equivalent of approximately $6.20/share. (Which actually begs a different question, "Why didn't I buy GW shares, which closed at $6.03 today in anticipation of the exchange?" I will leave the answer to this question to my readers' imaginations, or another day's discussion topic.) While this deal was pending, financing rates have also skyrocketed and PDS is now expecting to borrow at 11% and incur additional upfront costs in the form of original issuance discounts and fees of approximately US$76 million! To stay within caveats of financing, PDS will also have to significantly reduce its monthly distributions - they are anticipating paying out less than 1/3 of what they have paid before.
All that sounds rather disastrous, doesn't it? And to some extent, it really is and on some level I am even hoping that this deal will not close, but I know that it will and that the very astute PDS CEO - Kevin Neveu has some very good reasons to stick to the deal. I am convinced that the scare over GW acquisition costs is what drove this stock into the ground. More so than any other factor like the precipitous drop in the price of oil. This scare is also what created the present buy opportunity.
For other reasons I still like PDS, please take a look at my previous notes on the company from 2007 at http://stockvalues.org/new-investment-strategy.
Disclosure: long PDS.
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This article has 11 comments:
On Dec 19 01:40 PM notsosmart wrote:
> another self serving article.too many on this site.i own this stock.
Assuming that none of these will bankrupt the company, you've got a ticker trading for about twice cash-flow, an insane valuation for an industry stalwart.
Long PDS (@$16 boo), GW(@ $4.60 last month boo-yah!)
Bloomberg has dredged up a lot of the high-level details, though the Fed has stonewalled on some particulars. See:
Bloomberg.com/apps/dat...
> another self serving article.too many on this site.i own this stock.
Too few people read this blog for entries within it to be considered self serving. I thank you for being among this elite.
On Dec 19 02:12 PM User 19554 wrote:
> The key question here is why didn't you buy Grey Wolf stock?
The reasons that I did not purchase GW instead are many and complicated. Here they are, breifly:
1. Taxes on the cash portion of the distribution.
2. Discount over buying PDS directly would have only been about 3%.
3. If for some strange reason this deal does not close, GW stock would fall at least 50%.
4. I would need to be sure that the distribution instructions were received by the following day, or seriously risk getting screwed by only receiving PDS shares and not the cash.
On Dec 19 03:33 PM BLITZ wrote:
> Are you sure about the ceo they sometimes do crazy things at buyout time ala
> KEN FISHER @bank Of America, time warner-aol to name a couple.
I guess, you can never be sure, but I did get myself somewhat familiar with this fellow. He appeared to be very apt and a straight shooter, which is what you want under such circumstances. I didn’t get the connection between Ken and either Bank of America or AOL Time Warner
On Dec 19 04:15 PM turb0kat wrote:
> I think to say that it is the acquisition which torpedoed this stock
> misses the truth: the stock torpedoed because of the convergence
> of (a) impending payments on debt (b) expected slash in dividend
> (c) $100 drop in oil prices.
You are absolutely right – many factors are sinking this stock and some of these are macro. I was simply trying to say that PDS would be trading much higher, if it was not for factors tied to the GW acquisition.
On Dec 19 05:02 PM NanooGeek wrote:
> PDS recently announced an "in-kind" distribution, 'xplained as truing
> up the shares, or somesuch... which is likely to have tax consequences
> for ALL unitholders.
This is a very good point and you are absolutely right. They do these organizational distributions every year, as I recall, and those of us in the US who buy PDS, instead of the PD.UN on the Toronto Exchange get a little screwed by paying taxes to Canada for nothing. On the bright side though, these taxes are tiny and are also deductible on your US return.
Southwestern Energy and Equitable Res. US co's stll have annouced and confirmed recently massive US drilling in 2009, which PDS nimble mgmt can now take advantage of w GW and expiration of noncompete from old US divestiture. Long term these PDS shares will be good holding IF they can rapidly paydown/refi the debt when things get better.
we shall see, annual report will be very good reading this year for clues.
what are you supposed to buy/ RIG? they fled to Switzerland this week, an analyst said Swiss Franc is the next Iceland. If you want to own a driller, and with marcellus/etc. still hot you should own one, safe country CN potential currency appreciation play is a good hold.