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Summary

  • Continued weakness in the offshore driller industry presents a great opportunity for investors to establish positions during the cyclical downturn.
  • A projected decrease in dayrates has not come to fruition, but pressure remains on contract renewals and contracting out newbuilds.
  • As the market slowly shifts to value stocks, offshore drillers may start to return to favor as many stocks remain near 52 week lows.

After the offshore drillers began selling off in early 2014, I profiled 7 companies and gave my two cents on how investors should approach each company. Three months later, offshore driller stocks remain depressed, but positive developments and less uncertainty in the industry may lead to a return in investor sentiment. Over a three part series, I'll cover 9 offshore drillers. In this article, I'll profile Noble Corp (NYSE:NE) and Ensco (NYSE:ESV). The following 2 articles will be available shortly.

Part 2: Transocean (NYSE:RIG), Diamond Offshore (NYSE:DO), Atwood Oceanics (NYSE:ATW)

Part 3: Seadrill (NYSE:SDRL), Rowan Companies (NYSE:RDC), Pacific Drilling (NYSE:PACD), Hercules Offshore (NASDAQ:HERO)

Transocean

Seadrill

Noble Corp.

Ensco

Rowan

Atwood

Diamond

Hercules Offshore

Pacific Drilling

Peer Average

Share Price (5/13/14)

$42.38

$35.48

$30.45

$51.29

$31.12

$48.04

$51.29

$4.62

$9.52

N/A

Revenue per share (TTM)

$26.34

$10.53

$17.31

$21.45

$12.79

$16.70

$20.37

$5.81

$3.44

$14.97

Market Cap ($mil)

$15,018

$16,910

$7,830

$12,000

$3,910

$3,070

$7,090

$703

$2,100

$7,626

Enterprise Value/EBITDA

6.54

11.47

6.19

6.91

8.18

8.37

7.01

5.57

12.02

$8.03

P/E

10.7

6.7

10.0

8.4

15.3

8.6

13.9

N/A

83.3

19.6

Forward P/E

10.2

10.5

9.1

8.5

12.7

6.9

12.8

8.6

10.1

9.9

Price/Book

0.93

2.17

0.92

0.92

0.79

1.29

1.55

0.89

0.87

1.15

Profit Margin

14.80%

53.72%

20.26%

28.11%

15.99%

32.44%

18.33%

-8.97%

3.42%

19.8%

Total Cash ($mil)

$3,240

$1,160

$114

$173

$1,090

$59

$1,600

$197

$204

$ 871

Total Debt ($mil)

$10,700

$15,080

$5,730

$4,750

$2,010

$1,510

$2,490

$1,290

$2,440

$ 5,111

Debt/Equity ratio

0.64

1.83

0.62

0.36

0.41

0.63

0.54

1.52

1.01

0.84

Current Ratio

1.91

0.74

1.48

1.55

4.31

3.15

2.87

2.14

2.2

2.26

Yield

5.20%

11.40%

4.90%

6.00%

1.30%

0.00%

6.80%

0.00%

0.00%

4.0%

Diluted EPS

3.87

5.47

3.46

5.96

2.03

5.35

3.73

-0.53

0.12

3.27

Source: Yahoo Financials and CNBC

Industry Overview

(click to enlarge)

The doom and gloom in the offshore drilling market predicted by many analysts has by and large not affected the actual operations and profitability of companies thus far in 2014. It was predicted that dayrates would suffer as a glut of newbuilds came on the market and led to an oversupply of rigs. While the newbuilds coming into the market will continue through 2015, many companies have positioned themselves well to avoid newbuilds coming online without contracts. The majority of contracts are being renewed by clients, and in particular, there has been renewed strength in the Gulf of Mexico.

However, short-term demand uncertainty remains the biggest question mark in the industry, and it is the reason stocks remain depressed despite favorable quarterly earnings. As a result of this uncertainty, companies with solid balance sheets, newer fleets and long-term contracts in place are gaining favor.

Noble Corp.

Three Months ended 3/31/14

($ millions)

2014

2013

Y/Y % change

Revenue

$ 1,251

$ 971

29%

Operating Costs

$ 881

$ 741

19%

Operating Income

$ 369

$ 229

61%

Net Income

$ 256

$ 150

71%

EPS (diluted)

$ 0.99

$ 0.59

68%

Noble Corp reported great quarterly earnings on April 16, 2014. The company beat even the most aggressive EPS estimates due to high utilization rates and the addition of new rigs. Year-over-year, the company increased revenue 30% and net income 70%. What stands out most about Noble is the attractive dayrates the company was able to secure for its newbuilds. Most recently, the company delivered the ultra-deep water drillship, Noble Sam Croft, to Freeport-McMoRan (NYSE:FCX) for a three year contract with a dayrate of $632,000 commencing August 2014. The Noble Douglas is also slated to commence operations in late May 2014 with Anadarko (NYSE:APC) for a three year contract with a dayrate of $618,000/day. In 2013, Noble delivered three ultra-deepwater drillships and two high-spec jackups to clients. All these new rigs combined with 2 new jack-ups, Noble Houston Colbert and Noble Sam Turner, starting operations in early-to-mid 2014 means the company is set up to deliver continued impressive growth rates. As new rigs start delivering full quarter and year production, revenue growth should continue at 20%-30% for the remainder of 2014. EPS growth won't continue at 70%, as it did in 1Q2014, but will grow by healthy double digits. 2015 will really be the sweet spot for the company as all the new builds reach completion and begin production, while capital expenditures will drop significantly.

(click to enlarge)

Source: Noble Presentation March 24, 2013

The major question mark surrounding the company is the spin-off into Paragon Offshore. Under the spin-off, Noble will retain ultra-deep water drillships and high-spec jack-ups with the spin-off company keeping the standard jack-up fleet. The spin-off will give Noble one of the youngest and most modern fleets in the industry. Recently, the company announced the spin-off of Paragon will be paid out as a dividend of 100 percent of the shares of Paragon Offshore to Noble's shareholders during the third quarter of this year. This spin-off is still subject shareholder approval, but is expected to be approved at the next shareholder annual meeting. The biggest question remaining is how much this spin-off will benefit shareholders. With offshore drillers experiencing a cyclical downturn, analysts expect the spin-off to be completed at a low valuation, which could potentially lead to a lower dividend payment to existing shareholders. However, this spin-off dividend will be paid to existing shareholders tax-free.

(click to enlarge)

Source: Noble Presentation March 24, 2013

Capital expenses are expected to decline significantly going into 2015 as the current newbuild program comes to an end. With current demand uncertainty, management has stated they will be more conservative in adding newbuilds without contracts in place from customers. This will free up a significant amount of free cash flow in 2015, which could be used to pay down debt, increase dividend payments or repurchase shares. CEO and President David Williams said:

"Given the expected drop in our new rig reconstruction backlog, annual capital expenditures will decline substantially beginning in 2015 relative to the levels experienced over the past four years. Noble should experience strong free cash flow which will provide us with some options, we could utilize free cash to further address our dividend, currently at $1.50 per share per annum and yielding about 5% or given the reduction in share value seen over 2014 and I believe that the long-term fundamentals of the business are robust, we could repurchase shares."

Recommendation: Buy

Uncertainty in the pricing of the spin-off company, Paragon Offshore, remains a concern, but with low expectations in place, a low valuation at the IPO is probably priced in right now. Noble remains an extremely profitable company with new rigs starting attractive contracts throughout 2014. This will continue to give the company the solid growth seen last quarter. The stock is near its 52 week low, which gives investors an excellent entry point to get in on a cyclical downturn while enjoying a sustainable 5% dividend yield. The next 18 months look extremely positive for the company as it transitions itself and benefits from added newbuilds coming online while at the same time reducing capital expenditures by roughly $1.75 billion in 2015.

Ensco

Three Months ended 3/31/14

($ millions)

2014

2013

Y/Y % change

Revenue

$1,187

$1,149

3%

Operating Costs

$802

$747

7%

Operating Income

$384

$402

-4%

Net Income

$292

$317

-8%

EPS (diluted)

$1.25

$1.36

-8%

Despite turning in a less than stellar quarter due to a drop in overall utilization, Ensco remains one of the best managed offshore drillers. In an industry that can be bogged down with debt, Ensco has a great balance sheet with a long-term debt-to-capital ratio of 27%. The company also easily sustains its $3/share dividend for a forward dividend yield of 5.9%. Most recently, Ensco appointed Carl Trowell as its new CEO and President, effective June 15, 2014. The move comes as the company was looking to replace Dan Rabun, who announced his retirement in November of last year.

1Q2014 results were negatively impacted by a decline in total utilization to 78% from 86% a year ago. Planned rig upgrades and rigs coming off contract were to blame for the significant drop in utilization. Rigs coming off contracts without renewals in place were one of the biggest worries for analysts, and it hurt Ensco during the first quarter. Three rigs, ENSCO 8503, ENSCO 5002 and ENSCO 5000, operated last year but spent much of the first quarter without contracts. However, the company saw a 14% increase in the total average day rate to $239,000 from a year ago and has 2 rigs, ENSCO 5004 and ENSCO 5006, completing shipyard upgrades in preparation for multi-year contracts commencing later this year. The company will also have 2 new rigs, ENSCO 120 and 121, providing additional revenue during the second quarter. Ensco expects second quarter revenue to increase 4% over 1Q2014.

Currently the company has 8 rigs under construction with 2 under contract. Management expressed optimism that it will announce a contract soon for the ENSCO DS-8, which is scheduled to be completed during 3Q2014. The company continues to sell older rigs to help fund its upgrading strategy, and recently sold its 14th rig since 2010 for a pre-tax gain of $90 million. Ensco management believes in selling off older assets as opposed to spinning them off into a new company, as Noble is doing later this year.

Recommendation: BUY/HOLD

Despite a weak quarter, Ensco remains one of the best managed and safest offshore drillers. By properly managing its balance sheet, the company can weather a couple of tough quarters far easier than most offshore drillers. With up to 8 new rigs starting production through 2016, the company will see modest revenue growth in a controlled manner. Ensco's financials stack up favorably to other companies in the industry, as seen in the chart above. Investors can enjoy a dividend close to 6% while waiting for the company to bounce back.

Source: Reexamining Offshore Drillers: Buy, Sell Or Hold? Part I