Seeking Alpha
Long only, value, contrarian, dividend growth investing
Profile| Send Message|
( followers)  

Summary

  • Negative investor sentiment in the offshore drilling industry has created great entry points on quality stocks.
  • Investors can establish positions near 52 week lows and enjoy 7% dividend yields while waiting for a rebound in the industry.
  • Short-term demand uncertainty has created pressure on dayrates and contracting newbuilds.

In continuing my analysis of the offshore drillers, this article will cover Transocean (NYSE:RIG), Diamond Offshore (NYSE:DO) and Atwood Oceanics (NYSE:ATW). This will be part of a three part series covering the following stocks.

Part 1: Noble Corp (NYSE:NE), Ensco (NYSE:ESV)

Part 2: Transocean, Diamond Offshore, Atwood Oceanics

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 (5/16/14)

$41.60

$35.30

$30.03

$50.04

$30.12

$47.86

$49.84

$4.37

$9.51

N/A

Revenue per share (NYSE:TTM)

$26.34

$10.53

$17.31

$21.45

$12.79

$16.70

$20.37

$5.81

$3.44

$17.46

Market Cap ($mil)

$15,100

$16,600

$7,630

$11,760

$3,700

$3,070

$6,800

$702

$2,100

$9,663

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

11.00

6.40

10.10

8.30

15.50

8.70

13.90

N/A

83.30

Forward P/E

10.2

10.5

9.1

8.5

12.7

6.9

12.8

8.6

10.1

8.53

Price/Book

0.93

2.17

0.92

0.92

0.79

1.29

1.55

0.89

0.87

1.32

Profit Margin

14.80%

53.72%

20.26%

28.11%

15.99%

32.44%

18.33%

-8.97%

3.42%

27.00%

Total Cash ($mil)

$1,987

$1,160

$114

$173

$1,090

$59

$1,600

$197

$204

$1,026

Total Debt ($mil)

$10,700

$15,080

$5,730

$4,750

$2,010

$1,510

$2,490

$1,290

$2,440

$5,684

Debt/Equity ratio

0.64

1.83

0.62

0.36

0.41

0.63

0.54

1.52

1.01

0.68

Current Ratio

1.91

0.74

1.48

1.55

4.31

3.15

2.87

2.14

2.2

2.61

Yield

5.20%

11.40%

4.90%

6.00%

1.30%

0.00%

6.80%

0.00%

0.00%

3.60%

Diluted EPS

3.87

5.47

3.46

5.96

2.03

5.35

3.73

-0.53

0.12

4.27

Source: Yahoo Financials and CNBC

Industry Overview

(click to enlarge)

Analysts predicted that rig 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. Short-term demand uncertainty remains the biggest question mark in the industry, and it is the reason stocks remain depressed despite favorable quarterly earnings.

Transocean

Three months ended 3/31

($ millions)

2014

2013

Y/Y % change

Revenue

$ 2,339

$ 2,184

7.1%

Operating Costs

$ 1,599

$ 1,698

-5.8%

Operating Income

$ 672

$ 479

40.3%

Net Income

$ 466

$ 313

48.9%

EPS (Diluted)

$ 1.25

$ 0.88

42.0%

Transocean turned in an impressive quarter, beating expectations by wide margins, due to improved utilization and successful cost reductions. The company was able to improve utilization to 78%, up from 75%, in the previous quarter. Another bright spot was the company's success in reducing overhead and capital costs. Management lowered its 2014 expected operating costs to $5.1-$5.3 billion, down from $5.2-$5.4 billion. The company expressed optimism in the overall jack-up market as well as strength in Brazil, East Africa and the Gulf of Mexico.

While the company reported strong quarterly results and expressed optimism in the long-term fundamentals in the offshore industry, management expressed concern over weakening demand in the floater market and particular weakness in the deepwater market over the next couple years. This concern has already presented itself in the company's most recent fleet status report. Transocean was able to renew or extend 5 contracts, but not one saw an increase in dayrates. Dhirubhai Deepwater KG1 was awarded a three-year contract in Brazil, but its dayrate dropped from $510,000/day to $440,000/day. GSF Development Driller II was awarded a three-well contract in the Black Sea, but its dayrate dropped significantly from $606,000/day to only $360,000. While these contracts are far better than rigs sitting idle, it is of great concern when companies aren't willing to pay a premium for rigs. These lower rates were due to intense competition from competing offshore drillers, resulting in lower rates.

Transocean will be completing 2 separate spin-offs in 2014. The first will be a drop-down Master Limited Partnership-MLP (Transocean Partners) which has an IPO scheduled for the third quarter. The second is the recently-announced spin-off of 8 rigs in the UK's North Sea to create Caledonia Offshore Drilling Company. It is still unknown if this will be done by a private buyout, spin-off or IPO. This follows a trend in the offshore drilling industry as companies are looking to divest for older, less profitable rigs and focus on high-spec jack-ups and ultra-deep water rigs. The only question is how much value will be returned to shareholders as these spin-offs are being done at a time when investor sentiment is very low in the industry.

On May 16, shareholders approved an annual dividend increase from $2.24/share to $3.00/share. This 33% increase gives the stock a forward yield over 7%. This dividend increase gives Transocean the second highest yield in the industry, behind Seadrill .

Recommendation: BUY/HOLD

Transocean is an interesting play for the patient investor. At $41.50/share, the stock is historically cheap and gives investors a great entry point. 2014 will be a transitional year as the company gets ready for 2 separate spin-offs, which will give the company added financial flexibility and help modernize its fleet. Newbuilds Deepwater Asgard and Invictus will both commence operations in late 2Q2014 for three year contracts, which will help earnings in the second half of 2014, but competition for contract renewals among deepwater rigs has already shown that dayrates may continue to decrease in the short-term. At this point, I believe there is little downside in the stock. If investors can be patient and collect a 7% yield, while waiting for a market recovery, they will be handsomely rewarded. I would only recommend this stock to long-term investors with at least a 5 year timeframe.

Diamond Offshore

Three months ended 3/31

($ millions)

2014

2013

Y/Y % change

Revenue

$ 709

$ 729

-2.7%

Operating Costs

$ 523

$ 516

1.4%

Operating Income

$ 186

$ 213

-12.7%

Net Income

$ 145

$ 175

-17.1%

EPS (Diluted)

$ 1.05

$ 1.27

-17.3%

On the surface, Diamond Offshore delivered terrible quarterly earnings with revenue and EPS both declining. 1Q2014 was an odd quarter for the company, as many rigs were idle and slated to resume operations in 2Q2014. There were a total of 8 rigs that will report revenue in 2Q2014 that were either idle or only reported revenue for part of 1Q2014. In addition to the rigs reporting new revenue in 2Q2014, there are 8 more rigs that will either start new contracts or have increased dayrates in 2014.

(click to enlarge)

Source: Diamond Barclays Energy Power Conference 9/12/13

Diamond has undertaken a fairly aggressive newbuild program that will greatly benefit the company going forward. During 2014, BlackHawk, BlackHornet, Oynx and Apex will commence operations. Apex was also recently contracted by ExxonMobil (NYSE:XOM) for a dayrate of $485,000. The Onyx and BlackHawk will add significant revenue for the majority of 2014, but Apex and BlackHornet aren't slated to begin operations till the tail end of 2014. In total, these 4 rigs alone should increase EBITDA over $200 million in 2014 and over $600 million in 2015 (assuming BlackRhino and BlackLion receive contracts).

(click to enlarge)

Diamond has done an amazing job of growing in an intelligent manner without leveraging itself as many other companies have done. This gives the company flexibility to weather difficult quarters and still return value to shareholders without sacrificing its balance sheet. Its low debt structure has also allowed the company to pay special cash dividends in addition to the regular quarterly dividend. When taking the special dividend into account, the stock has a forward dividend yield of nearly 7%. This puts it on par with Transocean, but lower than Seadrill.

(click to enlarge)

Source: Diamond Barclays Energy Power Conference 9/12/13

While some offshore drillers offer comparable yields, they have only been paying high dividends for a couple years. Diamond Offshore has made returning value to shareholders through dividends a top priority since 2006. As seen in the chart above, no company comes close to the annual dividend distribution of Diamond over the past 8 years. Investors can rest assured that management will continue this practice and should feel comfortable that the 7% yield is sustainable going forward.

Recommendation: BUY

I've changed my tune on Diamond over the past 3 months based on impressive contract renewals and newbuilds coming on the market in 2014. Diamond should have strong earnings throughout 2014, based on new and escalating contracts. While many argue Diamond has the oldest fleet in the industry, the company has done a good job modernizing its fleet and maintaining an industry best balance sheet. As with Transocean, this stock will require a patient investor that can wait for investor sentiment to return to the industry and be happy with receiving a 7% yield.

Atwood Oceanics

Three months ended

2014

2013

Y/Y % change

Revenue

$ 273

$ 284

-3.9%

Operating Costs

$ 164

$ 149

10.1%

Operating Income

$ 108

$ 104

3.8%

Net Income

$ 73

$ 85

-14.1%

EPS (Diluted)

$ 1.13

$ 1.28

-11.7%

Atwood Oceanics is a smaller offshore driller with a fleet four ultra-deepwater drillships (three of which are under construction), two ultra-deepwater semisubmersibles, three deepwater semisubmersibles and five high-specification jackups. Quarterly earnings were negatively affected by the start-up delay of the Atwood Advantage for 22 days, which resulted in nearly $13 million of lost revenue. Being such a small company in comparison to the large offshore drillers, downtime has a far bigger effect on top and bottom line numbers.

The company has done a good job of contracting out its rigs with 92% of remaining days in 2014 contracted and roughly 80% contracted for 2015. The company suffered a slight setback when the Atwood Hunter contract start date was pushed back to at least the second half of 2014 due to customer delays. With a dayrate of $515,500, the delay of the Hunter will hurt third-quarter earnings.

(click to enlarge)

Attractive contract dayrates and a modern fleet have allowed Atwood to lead the industry in net income margin. This is extremely important, as it shows the company can operate at high-profit margins, which should only improve as three additional ultra-deepwater drillships are delivered over the next 18 months. The company has also done a great job of managing contracts to minimize rig downtime.

(click to enlarge)

Source: Atwood 42nd Annual Howard Weil Conference 3/24/14

Aside from the 2 newbuilds, Atwood Admiral and Achiever, Atwood's most important contracts have been secured well into 2016. This gives investors confidence of continued earnings growth without having large exposure to the current market uncertainty. However, being a smaller company, any rig idle time or weak contract renewal will have a greater degree of negative impact on earnings.

Recommendation: BUY

Atwood is one of the riskier offshore drillers due to its small size, but investors with risk tolerance could be rewarded by taking on Atwood at levels near 52 week lows. Investors have good visibility into future earnings with long-term contracts secured into 2015 and 2016. The stock also has the lowest forward P/E in my analysis, meaning there is very little downside. Earnings growth should continue as newbuilds are added to the fleet, but investors must be willing to hold the stock without receiving a dividend. I believe once the Atwood Achiever begins operations toward the end of 2014, the company will have a solid enough established core business to institute a dividend. The upside may be more than Diamond or Transocean, but this comes with added risk and no yield.

Source: Reexamining Offshore Drillers: Buy, Sell Or Hold? Part 2