Hold These Drillers For Big Gains

Includes: ESV, NE, SDRL
by: Winning Strategies


Drillers are offering solid dividends with high yields.

Strong investments from the energy sector are increasing the demand for drilling activities.

Three drillers are set to generate future growth with increased investments to enhance their fleet portfolio.

With stabilization of the economy, drilling and exploration companies are getting back on track. As a result, the position for drilling and exploration companies remains firm. This industry continues to see deep and ultra-deepwater acreage as a strong growth opportunity for capital investment. The Middle East remains an attractive region and the major source of demand for high specification jackup rigs. However, other markets like Australia, West Africa and South America also promise considerable growth for these companies. Mexico and Arctic regions are also presenting attractive opportunities as they hold about 13 percent of the world's undiscovered oil and about 30 percent of undiscovered gas.

In this article, I pick three drilling companies I believe have been making substantial profits from existing opportunities as well as establishing strong footprints for future growth. These companies are making gigantic investments to improve their rig portfolios and generating strong cash flows to return considerable cash to shareholders. Looking like a safe haven for dividend investors, these three companies are Ensco PLC (NYSE:ESV), Noble Corporation (NYSE:NE) and Seadrill Ltd. (NYSE:SDRL).

Why Noble is a good stock to hold

Noble is a leading offshore drilling contractor for the oil and gas industry. The company, with a fleet of 77 offshore drilling units, is located all over the world, including the U.S., Alaska, the Gulf of Mexico, the North Sea, Brazil, the Mediterranean, the Middle East, West Africa, India, Malaysia and Australia. Noble is also investing heavily to meet the demand generated from increased spending in the entire energy sector.

The company started its operations with the addition of three new ultra-deepwater drillships: Noble Bob Douglas, Noble Don Taylor and Noble Globetrotter II, plus the high-specification jackup, Noble Mick O'Brien in 2013. These newly added ultra-deepwater drillships and the high-specification jackup have added considerable revenue to the company's total sales. Further, in December, Noble had a delivery of two more JU3000N jackups, the Noble Regina and Noble Houston Colbert. The company is expecting the delivery of five more rigs by the end of 2014, which will make Noble a premium offshore drilling rigs provider.

With the addition of the new ultra-deepwater drillships and jackups, the company's revenue increased to $4.2 billion. The company's contract drilling revenue is increasing with the increased average daily rate of $212,000. In addition, its net income in 2013 improved to $783 million, up from $522 million in 2012. This current net income is equal to $3.05 per diluted share. The company is expecting further improvement in revenues with the addition of new rigs to its portfolio in 2014.

On the other hand, it has been generating strong growth in cash flows. Its operating cash flows stretched from $1.3 billion in 2012 to $1.7 billion in 2013. Its operating cash flows are providing support to its fleet expansion program and to borrowings through its commercial paper program. Although the company has been working on its fleet expansion program, which requires a large amount of capital, it is still returning significant amounts to shareholders in the form of dividends. The company has demonstrated this trend by increasing its dividend by 50 percent to an annual dividend of $1.50/share. The addition of new rigs and increased average daily rates ensures further growth in the company's earnings this year. These earnings will lead Noble to generate significant growth in cash flows, which will allow the company to sustain its dividend growth this year and into the future.

Why Ensco is a good stock to hold

Ensco offers offshore contract drilling services to both domestic and international oil companies. Over the past two years, Ensco has entered into several contracts to enhance fleet drilling rigs, including the recent addition of three new ultra-deepwater rigs to its active fleet. The company has started using these rigs to work on multi-year contracts. Further, Ensco entered into an agreement to build an additional premium jackup (ENSCO 110) and its eighth ultra-deepwater drillship (ENSCO DS-10), which are likely to be delivered in 2015. The company also accepted the delivery of its first two ultra-premium, harsh environment ENSCO 120 Series jackups. It is further looking to expand these ENSCO 120 Series jackups and recently came to an agreement for a fourth ultra-premium, harsh environment ENSCO 120 Series jackup that is anticipated to be delivered in 2016. In total, the company now has seven rigs under construction.

Solid demand for drilling activities all around the globe and strong investment in Ensco's fleet portfolio is creating a consistent stream of sales and income for the company. At the end of 2013, its revenue reached a record level of $4.9 billion, with strong contribution from both jackups and its floaters segment. An increase in the average daily rates in both jackups and floaters and the addition of newly built rigs to its floaters segment (ENSCO DS-6, ENSCO 8506 and ENSCO DS-7) allowed the company to post massive revenue. The company is quickly converting its revenue growth to massive income. At the end of the fiscal year 2013, Ensco's net income increased by 21 percent to a record $1.418 billion.

Strong top and bottom line growth is enhancing its cash generating potential as it has generated around $1.9 billion in operating cash flows, adequately covering its massive capital expenditure of $1.7 billion. Seeing a strong demand for drilling activities and the potential to fund investments from cash flows, it is further looking to increase its investments to $1.4 billion in 2014. In addition to aggressive investments, Ensco is also returning significant cash to shareholders; the company increased its dividend twice last year to an annual dividend of $3/share. Its dividend growth looks completely safe with double-digit growth in earnings and the ability to generate strong cash flows. It is paying around 37 percent of its income in dividends, which looks not only manageable but provides room for more increases. With the double-digit growth in earnings, its dividend could expand even further this year.

Why Seadrill is a good stock to hold

Seadrill is an offshore drilling contractor. It provides drilling and well services to the offshore industry. It has a fleet of drilling units that operate in shallow water, mid-water and deepwater areas in benign and harsh environments. Like its other group members, it is also strongly investing to enhance its portfolio. Seadrill is one of the best drillers among its competitors as it owns the highest percentage of assets in the premium classes. One hundred percent of its jackup fleet is high specification and 94 percent of its floater fleet is sixth generation ultra-deepwater. The company plans to keep this high exposure to the premium asset classes intact through capital investments and strategic M&A.

In the third quarter of 2013, Seadrill invested $235 million for the acquisition of a high specification jack-up rig, Prospector 3, which will deliver in the first quarter of 2014. In 2013, Seadrill acquired 13 newbuild rigs, while 20 rigs underwent construction. Three of those 20 rigs under construction have secured long-term contracts. With these 20 newbuild rigs, Seadrill is well set for future growth. Through these investments, Seadrill is securing long-term contracts, including an 18-month contract extension for the West Aquarius, a contract extension for the West Capella, with Total SA, and a one-year contract extension with Exxon Mobil in Malaysia for the West Leda. In addition, Seadrill made an agreement with Pemex for five potential jackups beginning in the first half of 2014 that has the potential of total revenue exceeding $1.8 billion.

Consequently, its order backlog at the end of 2013 reached $20.2 billion. The company is also in negotiations for medium to long-term contracts with the West Saturn and the West Jupiter. Seadrill has the ability to convert order backlog into revenues at a high pace. On average, in the past three years, its revenue growth has been at 11 percent. On top of that, it possesses the highest five-year revenue CAGR of 23 percent, compared with the industry average of 10 percent. Strong growth enables Seadrill to make consistent increases in its dividend and allows the company to continue this trend with the strong order backlog and with addition of new rigs to its portfolio.

In conclusion

Most of the drilling companies have experienced strong top and bottom growth over the past two years. They also invested heavily to improve their portfolios in order to meet demands. I believe these three drillers are on track and well set to generate future growth. Their dividends also seem to be in sustainable positions with their strong order backlogs and abilities to generate strong cash flows.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.