North Atlantic Drilling: New Contracts Strengthen Cash Flow But More Work Needs To Be Done

| About: North Atlantic (NADL)

Summary

North Atlantic Drilling has successfully secured two new long-term contracts for its rigs.

These contracts will serve to increase the company's revenue and cash flow beginning in Q4 2017.

The contract dayrates will be adjusted to market dayrate in 2019 and 2020, giving the company exposure to an improving market, should that occur.

It is quite difficult to predict what the actual impact on the company's revenue will be from these contracts, but it will be positive.

North Atlantic Drilling will continue to struggle until it secures more new contracts.

On Tuesday, April 11, 2017, harsh environment drilling specialist North Atlantic Drilling Ltd. (NYSE:NADL) announced that it has secured two ten-year contracts from ConocoPhillips (NYSE:COP) for the use of two of its drilling rigs, West Elara and West Linus. This is excellent news for the beleaguered driller, which has struggled to obtain work for its drilling rigs over the past year due to significant cost cutting throughout the industry. This has had the effect of making it very difficult to project the company's future cash flows and significantly punished the company's stock. These contracts will help to improve that situation by providing North Atlantic Drilling with much needed cash flow over the coming years.

The West Elara is a 2011-built independent leg cantilever jack-up drilling rig that has been specially constructed to withstand some of the harshest oceanic and weather conditions on Earth. The rig is capable of drilling wells up to 40,000 feet deep in up to 450 feet of water. These capabilities make it one of the most technically capable harsh-environment drilling rigs in existence today. The rig began work on its current contract with Statoil (NYSE:STO) in March of 2012 at a dayrate of $318,000. This contract ended last month and so the rig has not been producing any revenue for North Atlantic Drilling since that time.

The West Linus is a 2014-built independent leg cantilever jack-up drilling rig that, like the West Elara, is specially equipped to operate in some of the harshest environments in the world. This rig is also capable of drilling wells up to 40,000 feet deep in up to 450 feet of water. Together with the West Elara, the West Linus is one of the two most capable shallow-water rigs in North Atlantic Drilling's fleet and indeed one of the most capable harsh-environment jack-ups in the world. The West Linus began its current contract with ConocoPhillips in May of 2014 at a dayrate of $326,000. This contract was originally scheduled to end in May of 2019, a date which has now been changed to end of 2028.

The new contract for the West Elara rig is scheduled to begin early in the fourth quarter, in October 2017. This contract will be in effect until March 2020 and provide North Atlantic Drilling with a total of $160 million in revenue. If we assume that it will last from October 1, 2017 until March 31, 2020, this is 913 days. This works out to a dayrate of approximately $175,000 assuming a 100% utilization rate. Please note that this represents the longest possible contract time given the information that North Atlantic Drilling provided and thus the lowest possible dayrate. As should be immediately obvious, this is significantly less than the rig was earning under the contract with Statoil. However, it is much more than the $0 per day that the rig is generating now and considering how much dayrates have fallen since 2013, is quite respectable.

As I mentioned earlier in this article, the contract for the West Elara is for a total of ten years and March 2020 certainly isn't ten years away! Well, beginning after this aforementioned period, the dayrate on this contract is going to change. The new dayrate, which will be applicable until October 2027, will be indexed to the market dayrate. Unfortunately, North Atlantic Drilling does not state whether this dayrate adjustment will be a one-time thing or if it will be periodically adjusted over the contract term (presumably the latter). Given the lack of visibility into future dayrates given the current conditions in the industry, we thus cannot predict how much revenue West Elara will produce through this period. North Atlantic Drilling predicted in its news release that it will bring in approximately $530 million in total over this period. That works out to approximately $191,000 per day, but there is no way to be certain what the actual revenues will be.

As some readers may have already noticed, the second rig to secure a contract, West Linus, has already been working for ConocoPhillips for the past few years. Unfortunately, North Atlantic Drilling was forced to make a few concessions to secure this new contract. In particular, the company had to reduce the dayrate on the existing contract. According to the company, the total potential revenue over the April 2017 to May 2019 period has been decreased by $58 million. This works out to approximately $73,300 per day, effectively reducing the dayrate to $252,700 for the remainder of the current contract.

After the existing contract ends, the new dayrate (from May/June 2019 until the end of 2028) will be indexed to the then market rate, similar to the way it will be done for the West Elara. Once again, North Atlantic Drilling does not state how frequently (if at all) the dayrate will be adjusted over the contract term. Thus, especially when we consider the uncertainty of projected dayrates, we cannot accurately project the impact that this new contract will have on the company's forward cash flows. North Atlantic Drilling projects that it will receive approximately $706 million in revenue over the lifetime of this contract. That works out to approximately $200,000 per day, but as already stated the exact timing of and amount of these payments is uncertain.

Thus, it is quite difficult to examine these two contracts in any great detail at present. What we can say for certain however is that they will benefit North Atlantic Drilling. As shown here, North Atlantic Drilling would have had only a single rig in operation after May of this year prior to the contract announcement:

Source: North Atlantic Drilling Ltd.

Here is how the same chart looks now. As you can see, it is significantly improved.

Despite the improvements though, North Atlantic Drilling still has a long way to go to get back to a state of normalcy. As the chart shows, North Atlantic Drilling will still have six rigs, or 75% of its fleet, out of work after May of this year. Thus, while these two new contracts will prove positive for the company's cash flow going forward, the company itself will continue to struggle until it manages to secure more contracts.

Disclosure: I am/we are long NADL.

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.

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