Deep Sea Drillers Turning Back Up?

I've been waiting for this group to make a move and it appears, technically at least - they might be ready to go.

The fund's 5th largest position, Pride International (PDE) , announced after the close of business Friday it has completed its Latin America land drilling business which I discussed in an earlier blog entry here. This clears the way for Pride to turn from a land/sea driller into a pure play sea driller, and a focus on deep sea at that. Why is that important? Essentially the drillers are separated into 3 main groups: land, shallow water, deep water - of this group, the latter has all the pricing power in the group.

The names in the group I have been following (feel free to leave a comment if I missed one) are: Transocean (RIG) GlobalSantaFe (GSF) Diamond Offshore (DO) Pride International (PDE) (Pride is a not a pure play on the sector but morphing into 1 over time)

Transocean (RIG) and GlobalSantaFe (GSF) are merging to create a $50 Billion behemoth in the sector

GSF and RIG are essentially trading together, but I initiated a 250 share buy in GlobalSantaFe this morning (which will eventually turn into a Transocean position post-merger), as it trades at a slight discount to the acquisition price. I also added to a smallish Diamond Offshore (DO) position, and topped off the sector holding with a bit more Pride International as well. The charts for GSF, RIG, and DO all look stellar with a breakout above their 50 day moving averages (DO a few days ahead of the pack), and with the 2% spike today Pride is joining the pack. It needs to stay north of $35.50 at close to confirm this.

Again, I have liked this group for a long time. To buy them, you could take 1 of the 2 approaches. Buy them on the way down and wait out a turn - thus buying at potentially lower prices but sitting with shorter term losses and/or dead money for an indefinite time frame. Or wait for them to exhibit the turn and break out. While not being a TA maven, this appears to be a turn as all have recently hurdled some resistance.

As for valuations you ask? Well these are all trading at 10-12x 2007 estimates. Cheap you say!? Yes cheap, but this is a very cyclical business - and the valuations in the sector reflect that. The thesis from this blogger is these companies are moving from cyclical plays to secular plays, as it is getting more difficult to extract crude. The same thesis I am applying to the Core Laboratories (CLB), FMC Technologies (FTI), and National Oilwell Varco (NOV) trades. These 3 companies have already won over skeptics and now trade at 20+ forward PEs. The deep sea drillers, however, have not won over skeptics so certainly even a PE expansion to upper teens as these companies provide more predictable and consistent earnings would bode well, considering their earnings growth....

While I don't really want to be building too much more long exposure, as I await (tapping foot impatiently) this pullback (hello? pullback?), these names seem to be levered to the rising crude and I think just potently undervalued.

Long GSF, DO, PDE, CLB, FTI, NOV in fund; no personal positions

Comments

[Richie:]

You neglected to mention the "best of breed" of the deep water drillers - Oceaneering (OII). Listen to yesterday's conference call and you'll understand why they are BEST OF THE BEST.

Richie

2007 Sep 06 11:20 AM

[TraderMark:]

Thanks Richie - on first glance they don't look like a pure play driller but more of a service company in this niche similar to FTI - I am also high on that subsector: CLB, FTI, CAM, SII, et all. So I will add OII to the watch list for that group. Thanks for the feedback.

2007 Sep 06 12:47 PM