Atwood Oceanics Is 'Sell On Rally'

| About: Atwood Oceanics (ATW)

Summary

Atwood Oceanics has surged by 27% in three trading sessions and I see the rally as an opportunity to lighten positions in the stock.

While 1Q16 results have been robust on existing backlog, rigs going off-contract through 2016 will depress sentiments for the stock.

Even if rigs are re-contracted, it would be at a lower day rate, impacting EBITDA margin and operating cash flow outlook.

Sustained oil price recovery is not coming anytime soon.

Atwood Oceanics (NYSE:ATW) was among my favorite stocks in the offshore drilling sector and the company still owns a fleet of high specification rigs. However, with broad industry concerns still prevailing, I am bearish on Atwood Oceanics for 2016. This article discusses the key reasons to believe that the current rally can be used to sell positions in Atwood Oceanics.

Even in bad times for the industry or company, there can be trading rallies from oversold levels and Atwood Oceanics is a good example of the same. The stock touched a low of $5.32 on February 2, 2016. The stock has subsequently surged higher by 27% in few trading sessions, but I don't see the rally sustain for long.

I must add here that Atwood Oceanics reported strong results for the first quarter of 2016 and that is the primary reason for the current rally. However, the following concerns are likely to ensure that the stock trends lower in the foreseeable future -

While oil has trended higher in the recent past, the outlook still remains bearish considering the point that Iran oil supply will hit the markets soon coupled with the fact that the global economy is slowing down. Therefore, consumption growth is likely to remain very sluggish in 2016.

In the ultra-deepwater segment, Atwood Oceanics has two rigs that are going off-contract in May 2016 and November 2016. Atwood Osprey, going off-contract in May 2016, has a day rate of $445,000. Considering the current market conditions, I see idle time for the rig post current contract and this will hit the cash flow potential for FY16.

In the deepwater submersible segment, Atwood Oceanics has two rigs going off-contract in March 2016 and September 2016. Atwood Falcon is going off-contract next month and currently has day rate of $430,000. In my view, the rig is also likely to remain idle considering the current market scenario and is another cash flow impact factor.

In the jack-ups segment, Atwood Oceanics has two idle rigs and the remaining three rigs are going off-contract at different times in 2016.

The key point that I want to make here is that there can be several negative triggers lined-up for Atwood Oceanics if oil prices remain sideways to lower. As these rigs remain off-contract or are contracted at significantly lower day rates, the negative impact on cash flow and EBITDA margin will take the stock lower.

Among the positives, Atwood Oceanics still has two rig deliveries that have been postponed to September 2017 and June 2018. Therefore, payment for rig delivery is not coming immediately, but it remains to be seen how soon oil prices recover.

Also among positives, I must mention that Atwood Oceanics will not face any debt servicing issues through FY16 with Atwood Advantage, Atwood Achiever and Atwood Condor being the key EBITDA and cash flow contributors through the year.

Therefore, my concern is not from a credit perspective (debt servicing in 2016). My concern related to weakness in stock price through 2016 as the cash flow and EBITDA margin outlook is continuously revised in the coming quarters.

Continued escalation in geo-political tensions in the Middle-East is one factor that can provide upside momentum to oil prices in the foreseeable future. For investors who are considering short positions in the energy industry, this is the key risk factor. However, leaving this factor aside, oil is likely to witness more pain in the coming months.

In conclusion, Atwood Oceanics' surge by 27% in three trading sessions is a good opportunity to lighten up positions in the stock or consider some short positions. The bounce back from oversold levels is unlikely to sustain.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.