Avoid Noble Corp. For Now, Given Significant Challenges Ahead

| About: Noble Corporation (NE)

Summary

Noble reported a large loss in the fourth quarter 2015, but this was not as negative a sign as the headlines suggest.

Noble's loss was caused by the company retiring two of its rigs, which forced it to take a significant writedown.

In the long-run, these rig retirements are beneficial as they help to reduce the oversupply plaguing the industry.

Noble has joined the ranks of other drillers cutting costs, which will help protect the company's margins throughout the current downturn.

Noble has taken steps to reduce its debt, although not as quickly as I would like.

Offshore drilling giant Noble Corp. (NYSE:NE) announced its fourth quarter 2015 results on Wednesday, February 3, 2016. Overall, these results disappointed analysts as the company missed expectations on both top-line revenue and bottom-line earnings. However, there were some bright spots in the earnings report despite the analysts' disappointment. It is relatively common knowledge that the offshore drilling industry as a whole is quite weak, which is reflected in Noble's results. Overall though, the company is doing an excellent job of weathering these conditions and is taking the necessary steps to prosper in the current environment.

As my long-time readers are no doubt already aware, it is my usual practice to share the highlights from a company's earnings report before discussing those earnings. This is because these highlights provide a background for the remainder of the article as well as provide a framework for the resultant analysis. Therefore, here are the highlights from Noble's fourth quarter earnings report:

  • Noble reported total revenue of $858 million in the fourth quarter of 2015. This represents an increase over the $805 million that the company brought in during the fourth quarter of 2014.
  • The company retired two rigs in the quarter. These rigs were the drillship Noble Discoverer and the jack-up Noble Charles Copeland. This reduced the size of the company's fleet to thirty units.
  • Noble successfully reduced its drilling service costs by 3% during the fourth quarter. In 2015 as a whole, the company managed to reduce these costs by 18% compared to 2014 levels.
  • The company slightly increased its fleet utilization from 82% to 83% in the quarter.
  • Noble's average daily revenue declined on a quarter-over-quarter basis, going from $325,500 to $304,400.
  • Noble reported a net loss of $152 million in the fourth quarter. This works out to $0.63 per diluted share.

One of the first things that many readers are likely to note is that the company posted a loss in the quarter. However, this fact was not as bad as it may seem at first. This is because this net loss was caused by a one-time non-cash event and does not represent any money actually leaving the business. In addition, this is not something that is likely to become a trend in future quarters. As mentioned in the highlights, Noble retired two of its drilling rigs during the quarter, the drillship Noble Discoverer and the jack-up rig Noble Charles Copeland. As a result of this decision, accounting rules require that the company take a writedown or impairment charge equal to the value of the assets as listed on its books. As a result of this, Noble took a charge of $418 million in the quarter. This charge had the effect of turning what otherwise would have been a profitable quarter into a money-losing one.

In addition to the impairment charge, Noble's results were affected by a second one-time event, this time positively. This event came about due to a contract cancellation. This event occurred on December 18, 2015, when oil and gas giant Royal Dutch Shell (NYSE:RDS.A) announced that it cancelled its contract for the use of the Noble Discoverer drillship, which the company was previously using in its Chukchi Sea exploration program. As might be expected, this contract cancellation was prompted by the sustained decline in oil prices that has occurred over the past year and a half. This cancellation will naturally reduce Noble's forward revenue from the rig. However, as I have mentioned in several past articles, offshore drilling rig contracts typically include provisions that protect the cash flow of the drilling contract in the event that the contract is cancelled. In this case, Shell paid Noble 90% of the remaining potential revenue under the contract in one lump sum payment, which Noble recognized during the fourth quarter. The total amount recognized was approximately $140 million after-tax. This works out to $0.58 per diluted share and directed increased the company's net income in the quarter; however, this income will not be recurring going forward so it is important to keep in mind the reason why the company received this cash windfall. Excluding the effects of both this net gain and the previously discussed impairment charge, Noble would have earned $126 million in the quarter, so the company is still profitable on a recurring basis.

As with many companies in the industry, Noble has been actively taking steps to reduce its costs. This bore fruit in the fourth quarter, with the company managing to reduce its contract drilling service costs by 3% quarter-over-quarter. When combined with the cost reductions that the company managed to achieve in prior quarter, Noble has managed to reduce its costs by 18% in 2015 when compared to 2014. It seems likely that Noble will continue to cut costs throughout 2016. This will aid the company in protecting its margins as it seems unlikely that industry conditions will allow revenues to recover within the next year or so.

Unfortunately for Noble, it does appear likely that total revenues will decline over the next few years. This is evidenced by the company's contract backlog. At the end of September 2015, Noble's contract backlog totaled $8.1 billion. By the end of December, this value had fallen to $6.9 billion. This clearly indicates that Noble has been unable to secure new contracts to replace its current ones as Noble performs under them. This is unlikely to be a surprise to anyone that follows the industry. Ever since oil prices began to decline rapidly, it has been quite difficult for offshore drilling companies to secure rig contracts, particularly at the rates that prevailed during the previous industry boom. This will likely result in the company's revenues declining progressively over 2016 and 2017 as it completes work on its current contracts.

Further evidence that the company's revenues are likely to decline over the next two years can be found by looking at the percentage of the company's total rig days that are committed to contracts that Noble already has. A rig day is defined as one day per rig that a unit can operate. Thus, if a company owns ten rigs then it will have 3,650 rig days every year. Noble currently has 6% of its total rig days in 2016 committed to contracts, which consists of 56% of its total floating rig days and 81% of its jack-up rig days. This declines to 44% of the company's total rig days in 2017, consisting of 37% of its floating rig days and 52% of its jack-up rig days. Due to the fact that floating rigs are much more expensive for an exploration and production company to operate, it seems likely that Noble will experience significantly more difficulty securing contracts for those rigs over the next two years than for its jack-up rigs (although it will likely experience difficulty with both). Unfortunately, floating rigs are also much more profitable for Noble than jack-up rigs. These factors clearly point to the likelihood of declining revenues and profits over the next two years.

In numerous previous articles, I predicted that the offshore drilling industry as a whole would begin to retire its older rigs rather than maintain them both for cost-related reasons and to reduce the oversupply of rigs that is plaguing the industry. Noble's results showed evidence that this is in fact happening. As I mentioned in the highlights, Noble scrapped two rigs in the fourth quarter, Noble Discoverer and Noble Charles Copeland. Noble thus joins Transocean (NYSE:RIG), Diamond Offshore (NYSE:DO), and Ensco (NYSE:ESV), among others in reducing their rig counts. While the industry as a whole still has a significant amount of work to do to reduce the oversupply in the industry, this is clear evidence that progress is being made.

Noble has taken some steps to assist it in weathering the challenges that it will face in the coming years. In addition to reducing costs, the company also significantly reduced its debt. At the end of 2014, Noble had a total of $4.8 billion in debt, of which none was scheduled to mature in 2015. At the end of 2015, Noble had a total of $4.2 billion in long-term debt and $300 million in short-term debt. The company thus managed to reduce its total debt load by approximately $300 million over the course of the year. While this is nowhere near as impressive a reduction as peer companies such as Seadrill (NYSE:SDRL) managed to accomplish, it is still a positive sign.

In conclusion, Noble's earnings results were not as bad as the headline numbers might lead one to believe. However, the company still faces significant challenges going forward. It is taking steps to ensure its ability to weather these challenges, which is certainly promising. I do not, though, consider the stock a buy at this point. Given the challenges that the company will certainly face over the next few years, investors will likely have better buying opportunities should they wait.

Disclosure: I am/we are long SDRL.

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.