Ultra-deepwater drilling specialist Pacific Drilling (NYSE:PACD) announced its second quarter 2014 results on August 6, 2014. These results will certainly please investors in the company and they do an admirable job of showing Pacific Drilling's growth story playing out. This growth was achieved in spite of the challenging conditions in the industry, which may make it even more impressive. Furthermore, there are signs that Pacific Drilling is likely to continue its strong performance into the third quarter. Overall, it is a good time to be an investor in the company.
As long-time readers are no doubt aware, it is my standard practice to share the highlights from a company's quarterly report when analyzing its results. This is in order to provide background for the article as well as frame the resultant discussion. Therefore, here are the highlights from Pacific Drilling's second quarter results:
- Pacific Drilling reported second quarter 2014 revenues of $260.8 million. This compares favorably to the $225.6 million in revenue that the company reported in the first quarter and the $176.8 million in revenue that Pacific Drilling had in the prior year quarter.
- Pacific Drilling reported an EBITDA of $137.9 million in the second quarter. This represents a 61% increase over the prior year quarter.
- The company achieved a remarkable revenue efficiency of 97.1% in the second quarter.
- Pacific Drilling's cash flow from operations in the first six months of 2014 was $223.4 million. This represents a 110% increase over the comparable period in 2013.
- Pacific Drilling had a net income of $49.9 million in the second quarter. This represents a 124.8% increase over the first quarter of 2014.
- The company's net income in the quarter works out to $0.23 per diluted share.
This was the best quarter in the company's history in terms of revenue, a fact which seemed to please the company's management. The primary reason for the quarter-over-quarter increase was the company's remarkably high revenue efficiency, which at 97.1% was the highest in Pacific Drilling's history. In order to understand why increased revenue efficiency would lead to such a dramatic increase in revenue, it is important to understand exactly what is meant by revenue efficiency. As I have mentioned in several previous articles, offshore drilling rigs are only compensated by the oil company that has put them under contract for days that they actually operate. Thus, the rigs generate no revenue during periods of downtime, such as when the rig is undergoing repairs or maintenance. Revenue efficiency is the percentage of revenue that the rig actually generated compared to what it would have generated had the rig experienced no downtime. Obviously then, a higher revenue efficiency is preferable to a lower revenue efficiency. In the second quarter, Pacific Drilling had a low incidence of equipment breakdowns and very few periods in which it did not earn the full contract dayrate on its rigs. This allowed it to generate a higher percentage of its theoretical maximum revenue given its current rig contracts than ever before in its history. This is what caused the quarter-over-quarter revenue growth.
While Pacific Drilling has historically achieved a high uptime across its fleet, it is admittedly unlikely that the company can maintain this high of a revenue efficiency indefinitely. Fortunately, there are other factors that will result in growth in the third quarter. The first of these is a dayrate increase for the company's oldest rig, the Pacific Bora. The Pacific Bora is a 2010-built ultra-deepwater drillship that is capable of drilling wells up to 37,500 feet deep in up to 10,000 feet of water. The rig is currently being contracted by Chevron (NYSE:CVX) for operations in Nigeria for which the rig is earning a dayrate of $474,700. This contract is scheduled to end on August 26 of this year. Chevron recently opted to extend this contract for another two years at a higher dayrate of $585,860. This contract extension and corresponding higher dayrate will go into effect immediately following the end of the previous contract. Once this higher dayrate goes into effect, it will increase Pacific Drilling's revenues by approximately $111,160 per day ($10 million per quarter) that the rig operates over its present levels. As this increased dayrate takes effect at the end of August, it will prove incremental to Pacific Drilling's third quarter revenues and cash flow. However, this higher dayrate will have a much larger impact on Pacific Drilling's fourth quarter results as that will be the first quarter in which the rig will operate at the higher dayrate for the full quarter.
The second thing that will result in growth for the company in the third quarter is the start-up of operations for the company's sixth rig, the Pacific Sharav. The Pacific Sharav is a brand new ultra-deepwater drillship that is capable of drilling wells up to 40,000 feet deep in up to 12,000 feet of water. These specifications make the rig one of the most advanced and technically-capable drillships in the world. Construction of this rig was completed earlier this year and it is currently on its way to the U.S. Gulf of Mexico where it is scheduled to begin drilling operations for Chevron on September 1. Under this contract with the oil giant, the Pacific Sharav will earn a dayrate of $555,000. As with the Pacific Bora's increased dayrate, the initiation of this contract will prove directly accretive to the company's revenues in the third quarter but the full revenue impact of the rig's start-up will come in the fourth quarter as that will be the first quarter in which the rig is operating for the full quarter. Unlike the Pacific Bora though, in this case the company's revenues will be increased by the full amount of the dayrate as there was no previous contract and therefore the rig was generating no revenues.
The start-up of this rig will also prove accretive to Pacific Drilling's cash flow and EBITDA. In the second quarter, Pacific Drilling had direct rig operating expenses of $177,800 per day. This is a decrease from the $183,800 that the company had in the first quarter. If we assume that the Pacific Sharav will have similar operating expenses, then the start-up of this rig will likely increase the company's third quarter EBITDA by approximately $11 million, assuming that it does not incur significant downtime or experience start-up problems. The impact that the commencement of operations of this rig will have on the company's cash flow from operations is similar, but we need to remove the amount of taxes that the company will have to pay from this figure. The incremental tax expense caused by this rig is approximately 4% of the rig's revenue or $666,000 in the third quarter. That brings the Pacific Sharav's incremental cash flow from operations down to approximately $10.3 million in the third quarter, once again assuming that the rig does not incur start-up problems or significant downtime.
Pacific Drilling also has two rigs under construction that have not yet secured contracts. As these rigs will be completed and leave the shipyard in the third quarter of 2014 and the first quarter of 2015 respectively, the fact that these rigs do not have contracts could very much present a near-term concern. Fortunately, as Michael Acuff, Pacific Drilling's SVP of Sales and Business Development, pointed out in the company's second quarter earnings conference call, the company is currently in negotiations with an exploration and production company for the use of the Pacific Meltem. The Pacific Meltem will be the first of these two new rigs to leave the shipyard. Thus, there is a good chance that the rig will secure a contract by the time it is ready to begin work. This will likely be in the first quarter of 2015. Assuming that the rig does indeed obtain a contract, then it should prove to be accretive to the company's revenues and cash flow at that time.
Pacific Drilling's second new rig, Pacific Zonda, will also serve as a driver of growth once it secures a contract and begins working. But, as the Pacific Zonda will be under construction until early next year, it is unlikely to have a significant impact in the next few quarters. For this reason, Pacific Drilling has been smartly focusing its efforts on obtaining a contract for the Pacific Meltem. With that said, there are several oil and gas companies that are currently considering this rig for projects that they have starting next year. Therefore, there is certainly reason to be optimistic about this rig's potential to secure a contract and thus contribute to the company's forward growth.
Disclosure: The author is long PACD.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.