2) Symbol: NE
3) Price: $28.46
4) Shares Outstanding: 258 Million
5) Market Cap: $7 Billion
6) Book Value: $7.054.5 Billion
7) Enterprise Value: $7.408 Billion
8) EBIT: $1,919.6
9) EV/EBIT: 3.86
10) Earnings Per Share 2009: $6.42 TTM 2010: $6.34
11) P/E: 4.49
12) FCF per share 2009: $1,358.8 MM TTM 2010: $1232.7MM
13) Return on Invested Capital: 19.8%
14) Return on Equity: 23.18%
Noble operates a fleet of 62 offshore rigs that drill for oil and natural gas globally. About 60% of its customer base is national oil companies, which places the vast majority of Noble’s rigs internationally. The company also provides engineering and consulting and contract drilling services.
OFFSHORE DRILLING OPERATIONS
Contract Drilling Services
(NE) or Noble conducts offshore contract drilling operations, which accounted for approximately 99 percent, 98 percent and 93 percent of operating revenues for the years ended December 31, 2009, 2008 and 2007, respectively. They conduct their contract drilling operations principally in the Middle East, India, U.S. Gulf of Mexico, Mexico, the North Sea, Brazil, and West Africa. Pemex accounted for approximately 23 percent, 20 percent and 15 percent of their total operating revenues for the years ended December 31, 2009, 2008 and 2007, respectively. Revenues from Royal Dutch Shell plc and its affiliates accounted for 12 percent of total operating revenues during 2009. Royal Dutch Shell plc did not account for more than 10 percent of total operating revenues in either 2008 or 2007. No other single customer accounted for more than 10 percent of their total operating revenues in 2009, 2008 or 2007. (Straight from their 2009 10-K)
Noble is a contract oil and natural gas driller with operations that span the globe. Another great article on Noble was written up by Ravi Nagarajan which you can view at <seekingalpha>
Due to the horrible environmental tragedy in the Gulf of Mexico the U.S. government instituted a deepwater drilling moratorium so some of Noble’s existing contracts seen above are at jeopardy. These contracts can at times be broken by an extraordinary event like the moratorium but they are far more likely to be renegotiated. The reason for this is that the operators carry a large amount of the risk on a project and once these rigs leave the gulf, it can take several years to get them back because there are other areas such as Latin America, the coast of Africa, etc where large projects could tie up the rigs for years. An example of this hesitancy to terminally cancel contracts can be seen in the recent dealings between NE and NBL Noble Energy regarding the contract on the Noble Clyde Boudreaux rig which as affected by the moratorium.
The original contract terms were a day rate of about $605,000 until November of 2011. Due to the moratorium the contract was renegotiated to put the contract on standby between June and December of 2010. During this period which can be extended if both companies agree, the day rate will be $145,000 a day. Following this period NE will earn $397,500 a day on a contract that will last about 17 months which is what the original contract had left remaining.
Now we fully expect for other deep water rigs of NE and their competitors to face similar decreases in their day rates but it is generally not feasible for the contracts to be cancelled outright. At these revised rates we believe the companies will still be profitable but just at a reduced level. Fortunately for Noble their fleet has been kept up and is one of the higher quality fleets operating. They’ve spent about $3 million a year on maintenance of the rigs so if they were to be sold we are comfortable with the collateral values as opposed to some of their competitors who haven’t invested the same amount of capital for upkeep.
Currently Noble has about a $7.5 billion backlog which gives us as investors a good idea of the type of cash flow that they should continue to be able to generate. Unlike the issues with RIG and BP, NE has a sterling track record and has been ranked first in customer satisfaction for deep water operations, Latin American Operations, and the North Sea. With this said we do believe earnings will face significant downward pressure over the next couple of years as insurance costs will likely be significantly higher in addition to the lower day rates across the board.
Fortunately for NE they have an exceptionally strong balance sheet with a very reasonable debt load. This will be a huge help in allowing the company to be a survivor of the moratorium as we believe that weaker financed companies could be at jeopardy. Due to the quality of their fleet they could sell assets and reduce CAPEX to overcome any liquidity issues in the unlikely event that they would occur.
Also protecting Noble is the international reach of their operations. Below is a table from their 10K on the geographic breakdown of their revenue.
We feel that NE could basically earn their whole market cap in the next five years through cash earnings at the current stock price, and even with the current stress in the offshore drilling industry. We believe oil prices are likely to go much higher due to decreasing supply, a weaker dollar, and geopolitical drama.
If worse comes to worse and the moratorium continues for longer than we expect they should be able to shift most of the fleet to other areas. Recently a court in New Orleans overturned the legal basis of the moratorium but we don’t expect a big change as companies are scared to act without the blessing of the government at this time. Long term however the Gulf generates between 20-30% of our oil production in the United States and for us to be a more energy independent country offshore drilling must continue. We think the hysteria that dominates the news today will eventually die down.
Sell 1 NE Jan 12 30 put for $6.8 or $680
Target Profit: $680
Maximum Risk: $2,320
Days Remaining: 574
Target Net on Cash: 29.3%
Annualized target net on cash: 18.63%
Break Even Price: $23.20
Target Price: $48 or 6 times our 2012 EPS of $8 a share
We are selling the puts due to the high volatility of the stock, which allows us to reduce the risk tremendously because of the large premium we are able to collect. 18.63% annual returns with very little risk makes a lot of sense to us in this market where we don’t think the S&P 500 is likely to be up by more than 20% in the next two years. We’d suggest dollar cost averaging into the stock as well if it trades lower than $25.
Primary Risk Factors:
Extremely punitive restrictions on drilling due to the environmental tragedy in the Gulf of Mexico would certainly hurt earnings.
Higher insurance costs also will hurt.
A double dip recession could cost oil prices to drop hurting demand for offshore drilling.
Disclosure: Long NE stock, short NE puts