After the devastating Macondo oil spill, investors are naturally wary about the oil well services and equipment industry. The Street currently rates Noble (NE) near a "strong buy" and Transocean (RIG) a "hold." Based on my multiples analysis and DCF model, I am even more bullish on Noble and more bearish on Transocean.
From a multiples perspective, Noble is the cheaper of the two. It trades at a respective 26.4x and 9.8x past and forward earnings while Transocean trades at 15.8x forward earnings. With that said, Transocean does have a dividend yield that is nearly 500 bps higher at 6.6% and is 20% less volatile. Gross margins are also 400 bps lower at Transocean, which is a catalyst in the sense that it can be easily closed.
At the third-quarter earnings call, Transocean's CEO, Steven Newman, was quick to express weak performance:
Let me say at the outset how disappointed I am with the third quarter results. While there were some real positives on the marketing side of the business, we simply did not deliver the operational results we wanted.
For the third quarter, we reported a net loss of $0.22 per diluted share. After adjusting for discontinued operations and the other items noted in our press release, adjusted diluted earnings per share would have been $0.03. This compares to $0.59 for the second quarter of 2011.
When compared with the second quarter, the third quarter's adjusted results were impacted by lower revenues, higher costs and an increase in our effective tax rate.
Revenue efficiency further declined sequentially by 260 bps to 89.5% in the third quarter. With that said, the stock is up by 25.4% for the year to date. Part of the reason it is up stems from the Macondo ruling thus far. The court found that the company was protected against BP's claim that Transocean was liable for the more than $40B worth of cleanup costs. However, the court also argued that the indemnity did not extend to punitive damages related to the Oil Pollution Act and Clean Water Act. Given the uncertainty around future liability, the market reaction may have been too quick to react.
Consensus estimates for Transocean's EPS forecast that it will decline by 74.7% to $1.50 in 2011, and then grow by 96.7% and 58.6% in the following two years. Of the 27 revisions to estimates, 21 have gone down for a net change of -5.5%.
Noble, on the other hand, has a much brighter story going for it. As the market has finally accounted for much of the likely downtime arising from maintenance and rig build, the focus will shift to how well the company is transitioning in deepwater. While newbuilds are aggressively increasing scale, the offshore market is benefiting from improving trends. Given cash flow demands from construction, investors will likely have to be patient on capital allocation. Noble has done a stellar job thus far in divesting mature midwater rigs and jacks to help shift over into an offshore drilling brand. It recently reached a lucrative contract with Shell (RDS.A) that has a day rate of $530K plus a 15% potential bonus.
Consensus estimates for Noble's EPS forecast that it will grow by 166.4% to $3.49 in 2012 and then by 32.1% and 21.9% more in the following two years. Modeling a CAGR of 62.5% for EPS over the next three years and discounting backward by a WACC of 9% implies that Noble may eventually hit $67.94.