Pacific Drilling: Company Remains Speculative After Results

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About: Pacific Drilling SA (PACD)
by: Power Hedge
Summary

Pacific Drilling emerged from Chapter 11 protection after restructuring its debt maturities to all take place after 2023.

The company saw most of its financial measures get worse due to the reduced contribution from the Pacific Santa Ana.

PACD faces some potential problems next year, as the Pacific Sharav contract expiration will likely cause a massive cash flow decline.

The company struggles with having work for all of the rigs in its fleet.

It may be a buyout target, but overall, there are still too many uncertainties for me to recommend a position in the stock.

On Monday, December 3, 2018, ultra-deepwater drilling specialist Pacific Drilling (PACD) announced its third-quarter 2018 earnings results. At first glance, these results appear to be quite disappointing as the company saw its revenues decline year-over-year and posted a rather significant $6.78 per share loss. A closer look at the results though reveals that they were not really as bad as we might believe. The company does however continue to struggle with a few notable problems, particularly given the low utilization across its fleet, and the low dayrate environment that currently plagues the industry. As a result, Pacific Drilling remains a speculative play at best, despite the company's emergence from bankruptcy protection.

As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company's earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Pacific Drilling's third-quarter 2018 earnings results:

  • Pacific Drilling reported total contract drilling revenues of $56.673 million in the third quarter of 2018. This represents a 30.98% decline over the $82.110 million that the company reported in the third quarter of 2017.
  • The company reported an operating loss of $68.633 million in the most recent quarter. This is fairly comparable to the $68.452 million operating loss that it reported in the year-ago quarter.
  • The Pacific Bora ultra-deepwater drillship commenced work on its latest contract with Nigerian Agip Exploration Limited.
  • The company achieved a very impressive revenue efficiency of 99.8% during the quarter.
  • Pacific Drilling reported a net loss of $144.8 million in the third quarter of 2018. This represents an 8.06% improvement over the $157.5 million loss that the company reported in the third quarter of 2017.

The first thing that someone reading the highlights is likely to notice is that Pacific Drilling saw its revenues decline year-over-year. It also saw its revenues decline on a quarter-over-quarter basis as the company brought in total revenues of $66.6 million in the previous quarter. In both cases, the reason for the decline was the same - a fewer number of rigs operating under contract than in the preceding period. In the case of the quarter-over-quarter period, the Pacific Santa Ana completed work on its previous contract, so it spent fewer days in operation than it did in the second quarter. Therefore, the rig generated less top-line revenue for the company than it did during the previous quarter.

One area in which Pacific Drilling has always excelled is minimizing the downtime experienced by the rigs in its fleet. This is important because of the way that offshore drilling rigs are compensated. In short, a rig only receives dayrate for time that it spends performing drilling operations or performing other work for its customers. It does not receive compensation for time that it spends out of commission receiving maintenance or repairs. Ideally then, an offshore rig would undergo no downtime and spend the entirety of its contract duration engaged in drilling operations on behalf of its customers. However, this is impractical due to the fact that offshore drilling rigs are highly sophisticated machines and, like all such machines, require regular maintenance to operate at peak efficiency. Thus, the challenge for an offshore drilling company is to minimize the downtime experienced by its rigs while still ensuring that they receive all necessary maintenance and repairs. A company's revenue efficiency measures how effectively a company does this as it is the percentage of revenue that it actually brought in compared to what it would have had if none of its rigs experienced any downtime. As we can see in the highlights, Pacific Drilling had a revenue efficiency of 99.8% in the quarter, which is about as high as realistically possible. Thus, Pacific Drilling did an excellent job of maximizing its revenue based on the contracts that it currently has. This is something that investors should certainly appreciate.

As I have discussed in several previous articles on the company, one of the biggest problems facing Pacific Drilling is the lack of contracts that it has across its seven ship fleet. This has resulted in the company being forced to expend money to maintain its rigs while not generating any revenue to offset them. Fortunately, this problem is starting to improve, although it still has a long way to go before it is completely solved. As was mentioned in the highlights, the Pacific Bora started work on its latest contract with a subsidiary of Italy's Eni (E) in Nigeria. This brings the total number of operating rigs up to three, which is better than what Pacific Drilling has had in many recent quarters.

Source: Pacific Drilling

It is likely old news to anyone following the industry that new contract dayrates remain suppressed. I discussed this myself in a recent article. We can see this quite clearly in the contract for the Pacific Bora as the rig only has a dayrate of $150,000. As might be expected, these low dayrates suppress the company's cash flows. In fact, in the past, Pacific Drilling would not have even been able to generate positive cash flow at a dayrate of $150,000, but fortunately it has responded to the sustained period of low dayrates by implementing a variety of cost-cutting measures across its operations. These cost-cutting measures have allowed the company to reduce its cash flow breakeven level to $110,000 per day. Thus, it is actually able to generate a positive operating cash flow off of this $150,000 per day contract, although it is nowhere close to what it had a few years ago.

The company's fleet status report above also reveals another potential problem coming in the middle of next year. That is the conclusion of the contract for the Pacific Sharav, which is an older contract that boasts the kind of high margins that we saw earlier this decade. At $604,000 per day average revenue, this one contract is responsible for a significant portion of Pacific Drilling's total revenue. The offs that dayrates will stage a large enough recovery by next year to allow this rig to be resigned to a new contract at anywhere close to this contract are essentially non-existent. As we saw from Seadrill Partners' (NYSE:SDLP) West Capella contract, dayrates are most likely going to remain suppressed for quite some time. Thus, the company will almost certainly see its revenues and cash flow decline sharply when this contract terminates.

The primary purpose of Chapter 11 bankruptcy protection is to keep creditors off of a company's back while it restructures its balance sheet and comes up with a plan that everybody involved can agree to. Pacific Drilling managed to have some success here as it emerged from Chapter 11 protection on November 19, 2018, with no significant debt maturities until 2023. This is something that is critical considering that the end of the Pacific Sharav contract could quite easily strain the company's cash flow as we head into next year. After all, it needs to be able to make its interest payments before we even worry about rolling over debt. The hope here appears to be that the market for offshore drilling rigs will improve significantly by 2023, thus greatly improving the company's ability to roll over this debt or even pay it down early. Over the next year or two at least, that might be a pretty big assumption to make, although I do think that we will probably see some improvements over time.

In conclusion, I continue to believe that Pacific Drilling is a rather speculative play at best. While the company has certainly been making a valiant effort to weather the poor conditions in the industry, the completion of the Pacific Sharav contract in the middle of next year remains a major point of concern given the impact that it is likely to have on the company's cash flows. Fortunately, the resolution of the company's Chapter 11 proceedings seems acceptable and I do think that Pacific Drilling will be able to either weather the current environment or get bought out, but there are still too many concerns in my mind to recommend a position on the stock.

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.