Seeking Alpha
What is your profession? ×
Long/short equity, growth at reasonable price, research analyst, deep value
Profile| Send Message|
( followers)


Contract weakness in the deepwater drilling market provides opportunities.

Bifurcation of the rig market and long-term demand suggest a better environment by 2016.

Ocean Rig is extremely cheap based on forecasted growth.

The market for deepwater drillers has been plagued by fears of a slowing market hitting at the same time as newbuilds hitting the market. Under this scenario, the general move amongst the drillers is to pull back orders for new deepwater drillships despite the ongoing suggestions that the market will improve by 2016 and long-term demand for new rigs remains high.

At the Q1 '14 earnings release, Ocean Rig UDW (NASDAQ:ORIG) made the announcement that it had ordered two drillships on April 8 scheduled for delivery in 2017. The news came as other aggressive drillers such as Seadrill (NYSE:SDRL) and Atwood Oceanics (NYSE:ATW) proclaimed pauses in ordering plans due to the lingering issues in the market, while Transocean (NYSE:RIG) ordered two rigs. For investors who don't think those moves are prudent, Ocean Rig provides a cheap way to play an aggressive newbuild plan.

Expanding Market

Not only is the market for deepwater drilling expected to expand in the decade, but also the need for new rigs is exponential with the large amount of drillships reaching retirement age. By 2016, any new rig added to the market will easily replace a rig 30 years or older. The bifurcation in the market continues to favor building new rigs, yet most drillers have chosen to take a pause in ordering rigs despite the roughly three-year timeline for construction.

(click to enlarge)

Source: Ocean Rig presentation

According to Seadrill, the market for deepwater rigs is expected to reach 455 by 2020. When combined with the rigs reaching scrap age, the forecasts are for the market needing to construct 165 rigs during the time period, assuming the retirement of only 50 rigs. The above slide from Ocean Rig suggests a higher scrap rate. With limited new rigs order after 2015, the market is setting up for a supply problem by 2016.

(click to enlarge)

Source: Seadrill presentation

Ocean Rig Setup For Growth

The rigs ordered in April are 7th generation, new integrated design drillships to be constructed by Samsung Heavy Industries. The scheduled deliveries are February 2017 and June 2017 at a cost of approximately $685 million each.

On top of ordering two new drillships, Ocean Rig delayed the delivery of the ultra deepwater drillship, Ocean Rig Santorini, from late-2015 to mid-2016. The combination of ordering two new rigs and delaying the delivery of another leaves the company with limited downtime exposure to the current weak contracting market and sets the company up for solid growth once the market improves in the expected timeframe of 2016.

Ocean Rig has nine working rigs now and another with expected delivery in early 2015 providing for 30% rig growth when the three ultra deepwater rigs are delivered in 2016 and 2017. Atwood Oceanics has a similar size and has completely remade the company with the building of new rigs, including three rigs currently under construction during the last few years. Atwood declined to accept an option to build a new ultra deepwater drillship, leaving the company with the latest rig joining the fleet at the end of 2015.

Bottom Line

With earnings expected to grow over 50% on average in the next five years, Ocean Rig is a cheap stock. The stock only trades at roughly 8x 2015 earnings of $2.26. In addition, the aggressive move to go ahead and lock in new drillships during this weak period in the market sets them up to rally the most when the market improves by 2016. Investors should own Ocean Rig at this valuation and hold for the market recovery.