Atwood Oceanics: Upcoming Ultra Deepwater Rig Additions Not Priced In Stock

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 |  About: Atwood Oceanics Inc. (ATW), Includes: NE, RIG, SDRL
by: Long-Short Value

Atwood Oceanics (NYSE:ATW) is a medium sized high specification offshore driller similar to Transocean (NYSE:RIG), Noble Corp (NYSE:NE) or Seadrill (NYSE:SDRL), but smaller in market capitalization and fleet size. Atwood revenues are primarily driven by the day rates that Exploration and Production (E&P) companies around the world pay Atwood for the leases and drilling services on each of their ships in their fleet, commonly known as "rigs" within the industry. Atwood currently operators 13 (soon to be 14 as the Atwood Advantage was just completed). While many of Atwood's competitors offer more diverse fleets including Jackups, Drillships, Ultra Deepwater Drillships, Semi Submersibles, and Drill Barges, Atwood fleet contains only Jackups, Ultra Deepwater Drillships, and Semi Submersibles. Here is the Wikipedia entry for oil rigs which will give you an idea of what each type of rig does.

Industry Outlook

The offshore drilling industry took a big hit in recent years, both from the overall global slowdown and from the Macondo Oil Spill in the Gulf of Mexico. Both of these events effected many things with the industry including, revenue growth, stock performance due largely to the re-valuation of the industry that incorporate additional risks associated with operating offshore rigs. These effects from the overall global slowdown caused a depressed oil price, which is a major negative for the drilling industry as Offshore Oil is typically a more expensive and capital intensive venture than onshore drilling. As oil prices have stabilized post the financial crisis, offshore investment has and will continue to regain a majority of its investment which benefits companies like Atwood. If you are bullish on the price of oil, as I am, you should be bullish on offshore drillers.

Rig Additions

Atwood, like many of its peers have been in an expansion mode over the last few years, and many of these new additions from the industry are beginning to come online. Atwood has four new Ultra Deep-water drillships currently under construction. These Ultradeep water drill ships are rated to operate at depths of 12,000 feet under sea level, which is particularly important as oil finds get increasingly more rare, the depths at which new deepwater drilling will occur will continue to get deeper. Two of these drillships will be completed and put into service in the next 6 months, the Atwood Advantage (December 2013) and the Atwood Archer (June 2014). These drillships will have high Utilization rates compared to the rest of Atwood's fleet, because of their rated drilling depth. Atwood's four new drillships are summarized here in its Fleet Summary.

Atwood has signed multi-year contracts up to 2017 with Noble Energy and Kosmos Energy respectively for both of these drillships. These two drillships day rates are higher than any other day rates of any of the ships in Atwood's current fleet, and are projected to add $325 to $350 million in revenues to the company in 2014 (depending on exactly when Atwood Archer comes online). Assuming some delay, I think $325 million revenue addition in 2014 is likely. This revenue increase will increase Atwood's revenues by 31% in 2014 over 2013 projected revenues. Assuming that Atwood can drive similar margins on these new rigs to the margins that they currently run, that could add $1.67 earnings per share in 2014, making their EPS for 2014 close to $7.50 per share. You can confirm that my analysis is directionally correct because the 2014 consensus EPS is $8.09 (the difference likely being savings from projected debt reduction savings and other rate increase on current fleet). Going forward Atwood will add the other two Ultra deepwater drillships in 2015 which will add similar amounts to revenue and earnings. Atwood's Forward PE ratio for next year is currently 6.4 compared to RIG, NE, and SDRL at 8.63, 8.57, and 11.03 respectively. I believe that Atwood should and will trade in line with RIG and NE at a forward PE ratio of around 8.5, which yields a price of $68.75 based on consensus estimates.

Valuation

Looking at the EPS projections of Atwood is only one metric to understanding the overall valuation. Being a value investor, I think that the most important thing you must understand before making an investment decision is the valuation of the potential investment. There are two ways that I like to value a stock, both provide some insight into the potential investment. DCF (Discounted Cashflow) analysis & Reverse DCF Analysis (in which you try to derive the growth rate that the investment would have to validate the current market price).

Using conservative assumptions that post 2014, the revenue growth becomes more in line with the historical average of 15% per year over years 2-5, my Discount cash flow analysis of Atwood yielded an Estimated Value per share of $71. This was largely driven by the fact that Atwood is currently Free cash flow negative, as its capital expenditures largely outpace its cashflow from operations due to the recent additions of its 4 ultra deepwater drillships. Once these ships are part of the cash flow generating fleet, this imbalance will change and the company will start to produce more normal sustainable levels of Free cash flow.

Terminal cash flow

$ 539.99

Terminal cost of capital

7.50%

Terminal value

$ 11,999.78

PV(Terminal value)

$ 4,371.15

PV (CF over next 10 years)

$ 1,388.64

Sum of PV

$ 5,759.79

Value of operating assets =

$ 5,759.79

- Debt

$ 1,271.30

+ Cash

$ 88.77

Value of equity

$ 4,577.26

Value of equity in common stock

$ 4,577.26

Number of shares

64.06

Estimated value /share

$ 71.45

Price

$ 51.50

Price as % of value

72.08%

Click to enlarge

Looking at the reverse DCF is even more revealing which shows that Atwood is currently priced to grow annual revenues at 5.9% over the next five years. With the growth of revenues of 31% projected in 2014, I believe it is highly unlikely that Atwood would have an average revenue growth rate of 5.9% over the next five years. This can also be tested with this simple reverse DCF calculator (I prefer excel, as it's more accurate).

Summary

- Atwood Oceanics current stock price does not accurately reflect the upcoming addition of 2 Ultra Deepwater Drillships which will transform their fleet into a more technologically capable fleet able to sustain high utilization rates

- Atwood's valuation is out of line with its larger peers, Transocean and Noble Energy, and will likely see the stock revalued in Q1 & Q2 of 2014 as revenues from the Atwood Advantage are realized.

- Free cashflow will begin to turn positive in 2015 allowing further additions to its fleet or return of capital to shareholders.

- Recent upgrade of Atwood's Debt is a positive sign that the company balance sheet is sustainable, and I trust debt analysts more than equity analysts most of time as they deal with the here and now.

Disclosure: I am long ATW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.