The downside can be attributed to a drop in utilization rates to 91% in the period compared to 94% for the previous quarter and 97% in 4th Quarter 2005. Also, day rates decreased slightly from 3rd quarter levels. Despite earnings being below both internal and consensus estimates, they still displayed very strong year over year earnings and revenue growth rates in excess of 100%.
After reviewing the information provided by management in Bronco’s conference call, we now expect full year 2007 earnings per share of $2.68 and 1st Quarter 2007 earnings of $0.54. The downward revision can be attributed to management calling for a Q1 utilization rate in the low to mid 80s. Management is looking for utilization rates to stabilize in the 2nd Quarter and eventually return to previously attained levels.
Supply of rigs has increased in recent quarters while demand has dropped slightly, both negatively effecting Bronco’s prospects in the short term. They have continued their refurbishment program and intend to do so until commencing it at the end of the 1st Quarter. By that time, Bronco should have 54 rigs in opertation, compared to an average of 50 operating rigs in Q4 2006.
Management placed much of the emphasis of the conference call on their newly acquired well services division. The well services industry is expected to grow at a faster rate than the well drilling industry, as the unusually high growth rate in operating drilling rigs experienced in the past few years will result in increased demand for services on these wells in the near future. Earnings in the divison are also less subject to swings caused by moves in the energy markets, the well services industry is less cyclical than the well drilling indurty. They are looking to further grow their presence in this field, possibly by acquisition with excess cash flows once the refurbishment program is suspended at the end of Q1. If no attractive acquisitions surface, the excess cash will be used to retire outstanding debt, shoring up the balance sheet.
While the conference call should be viewed as a net negative event, with management anticipating a sizable decline in utilization rates in the current quarter before eventually stabilizing and firming up later in the year, the positive commentary on their well services’ operations is encouraging.
Also, I view Bronco’s decision to suspend their refurbishment program as a positive, as current industry conditions make growing their well services division by acquisition or cleaning up their balance sheet a more sensible way to invest capital provided by operations for the time being.
Given our new view of full year 2007 earnings per sare of $2.68, and maintaining our view of shares being worthy of carrying a P/E of 12, we our lowering our 12 month price target to $32.00. However, despite the lowered price target, I am maintaining my belief that shares of Bronco Drilling represent significant value at these prices, therefore maintaining a strong buy rating on Bronco Drilling Company.
In the short term, continued selling pressure may prevent shares from appreciating too much as Wexford Capital, former private owner of Bronco Drilling and now large shareholder who has been unloading shares for some time now, continues to sell off their stake in the company. Also, a now expected weak Quarter 1 may hold back shares in the short run as well. However, if rates stabilize and improve in the later part of the year, as management has siad they anticipate, Bronco will be well prepared with 54 operating rigs and a well services division. Even with a weak 1st Quarter expected, their comparable year over year growth rates should still be impressive with earnings per share gains of over 20%, deserving of a P/E multiple of 12. Currently trading at a trailing P/E of 6.3, Bronco remains attractively valued.
Disclosure: The author has a long position in Bronco Drilling Company.
BRNC 1-yr. chart: