Seeking Alpha
Long/short equity, portfolio strategy, dividend investing, growth
Profile| Send Message|
( followers)  

Summary

  • The oil and gas exploration industry has strong momentum because of a stabilization in oil and gas prices.
  • Transocean is experiencing low demand for its rigs.
  • Ensco and Noble are set up for strong future growth as a result of recent investments in their fleet portfolio.

The drilling industry has good momentum because of the recent growth in the economic environment and the stabilization of oil and gas prices. Most companies that work in the energy sector have increased their capital spending in order to reach new sources of production. Thus, the demand for drilling activities has grown over the past two years and will likely continue to grow in the coming days. Amid this, drilling companies like Transocean Ltd (NYSE:RIG) are expecting the pace of demand to remain slow in the short-term. This trend is reflected in Transocean's backlog, which decreased by close to $1 billion in the past month alone.

Transocean operates in the contract drilling business segment. Its business is to contract out its mobile offshore drilling fleet, work crews and related equipment on a day rate basis. The company provides drilling services and equipment for harsh environments and deepwater production throughout the world. Its drilling fleet is one of the handiest fleets in the world, and it features the latest floaters and high-specification jackup rigs.

Over the last two quarters, Transocean's backlog has decreased, and its uncommitted days have increased. It has contracted 24 of its 46 high-specification floaters through the end of 2014. Its mid water floaters are also showing signs of weakness particularly in U.K and Norway where there are still three units available in its active fleet. However, demand for its high specification jackups is high as only two of its 11 high-specification jackups are available in 2014. Unfortunately, its uncommitted days are increasing as shown in the table below.

2014

2015

2016

2017

High-Specification Floaters

29%

55%

68%

75%

Midwater Floaters

33%

53%

89%

100%

High-Specification Jackups

10%

39%

69%

87%

Source: SEC Fillings

There are many reasons behind the increase in uncommitted days. The most important is because the speed of tendering and the length of contract terms have decreased. In addition, Transocean is experiencing fierce competition for each tendering opportunity. Its closest peer, Seadrill (NYSE:SDRL), has more modern fleets than Transocean. This impacts the company's contract winning ability. Transocean has been allocating capital to modernize its fleet and even though the company has encountered some short-term headwinds, its high specification rigs the Asgard and Invictus are expected to commence operations in mid 2014, and it has five other high specification floaters under construction.

Along with the Asgard and Invictus, it placed three newly built high specification jackups in service last year. Transocean is expecting to generate higher revenues in 2014 because of the new rigs. After experiencing a decline in earnings and revenues in 2013, the company reshuffled its strategy. It is now looking to spin off its low specification drilling units, and it recently announced the creation of a new company comprised of eight of its U.K. North Sea Midwater Floaters.

Transocean is making moves to grasp new business opportunities, and in the first quarter its earnings showed some positive signs. After experiencing a tough past few years, the company reported significantly higher first quarter earnings. In addition, it expects to post better full year earnings in 2014. Despite the improvements, the company's cash position is not good. In the past few years, the company has faced difficulties such as the Macondo oil well incident and tax-related problems with the Norwegian government. The company has to pay $1.4 billion as a result of the Macondo incident, and nearly $1 billion already has been paid in settlement. The company's operating cash flow is not covering its capital investments in the first quarter, its operating cash flow was $136 million, and its capital expenditures came to $1.1 billion, leaving it with a free cash flow of -$995 million. Due to its negative cash flow, I believe that the company will find difficulties in paying dividends.

Where Do Ensco and Noble Stand?

The fortunes of operators like Ensco PLC (NYSE:ESV) and Noble Corporation (NYSE:NE) are trending higher. They both have entered into attractive contracts for their newly built rigs.

Over the past two years, Noble has been aggressively adding new assets and enhancing its existing fleets. The company is also disposing of non-core assets. Last year, it added three new ultra-deepwater drillships, the Bob Douglas, the Don Taylor and the Globetrotter II. In addition, it added the Mick O'Brien which is a high-specification jackup rig. In 2014, Noble has taken delivery of two more jackups, the Sam Turner and Houston Colbert. Going forward, it will take delivery of two additional ultra-deepwater drillships and three high-specification jackups. As a result of the fleet expansion, its year-over-year revenues are rising. This was evident in 2013, when Noble's revenues increased to $4.2 billion from $3.5 billion in 2012. In the first quarter of 2014, the company's revenues increased by 7% to $1.3 billion compared to $1.2 billion in the fourth quarter of 2013.

Ensco is also enhancing its fleet portfolio. It recently entered into several contracts to upgrade its fleet including the purchase of two premium jackup rigs the (ENSCO 110), and the (ENSCO DS-10). It also contracted for the purchase of two premium jackup rigs, the (ENSCO 110) and the (ENSCO DS-10). It also contracted for the purchase of two high-specification jackups (the ENSCO 140 and 141) and four ENSCO 120 jackup rigs. The first of the four ENSCO 120 series jackups commenced operations in North Sea and two others from the series have been contracted for before their delivery. Thus, with its portfolio of premium floaters and jackups, its revenue growth is very strong. In addition, the company's backlog is increasing and reached the record level of $10 billion at the end of the last quarter. Ensco's cash position is strong enough to support both its fleet expansion programs. It has a $2 billion revolving credit facility, a $10 billion contract backlog and about $123 million in cash and cash equivalents.

In Conclusion

ESV

NE

RIG

Industry Average

Price/Earnings TTM

8.3

10.0

9.7

11.7

Price/Book

0.9

0.9

0.9

1.3

Price/Sales TTM

2.4

1.8

1.6

2.1

Rev Growth (3 Yr. Avgas)

43.2

14.7

6.1

12.4

Net Income Growth (3 Yr. Avgas)

34.8

0.4

15

16.5

ROE TTM

11.5

9.8

9.3

8.3

Debt/Equity

0.4

0.7

0.6

0.7

Source: Morningstar.com

Transocean was slow to enhance its fleet portfolio and that is making it difficult for it to secure new contracts. Looking forward to the company's new build floaters are expected to provide considerable growth to its revenues and earnings. Its decision to spin off eight of its midwinter floaters will also work to improve earnings. Further, its plan to create a Master Limited Partnership will reduce its tax burdens and enhance its cash generation potential. Still, its cash position is not as strong as Ensco and Noble.

Ensco and Noble have created a premium portfolio of assets which has enabled them to grow their backlog and revenues. Further, both companies have strong enough cash positions to sustain returns and continue with their fleet expansion programs. All three of these companies are trading at attractive multiples, but Ensco and Noble look like the better investments to me. They both have made timely investments and are in strong enough financial and cash position to sustain their momentum. While Transocean is establishing its footprints for future growth with moves like the spinoff and the addition of new build assets, I believe it will take some time for the company to reestablish itself.

Source: Is Transocean A Better Buy Than Ensco And Noble?