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Oil & Gas Part III: ESV, SDRL or ATW? Does a 12% Dividend Change Your Mind?

March 17, 2014 | About:

In Part II of this series, I narrowed down the best opportunities among offshore drilling contractors to ESV, SDRL and ATW. Based on fleet mix, these three contractors appeared to be the best positioned to take advantage of the increased demand for deepwater drilling. Furthermore, all three companies appeared profitable and relatively cheap.

In this article, I’d like to take a closer look at the three companies. Let’s start with an overview of their fleets, both today and projected to the end of 2015:

Current Operable Fleet Avg Utiliiz. Avg Day Rate $k ESV SDRL ATW
Drillships (4,000'+ WD) 99% 504 10% 14% 27%
Semisubs (4,000'+ WD) 90% 431 21% 29% 27%
Jackups (IC 300'+ WD) 93% 166 34% 47% 45%
Total     65% 90% 100%
           
Projected Fleet (DEC-15) Avg Utiliiz. Avg Day Rate $k ESV SDRL ATW
Drillships (4,000'+ WD) 99% 504 11% 23% 43%
Semisubs (4,000'+ WD) 90% 431 20% 26% 21%
Jackups (IC 300'+ WD) 93% 166 34% 44% 36%
Total     66% 92% 100%

Deepwater floaters (particularly ultra deepwater drillships) are expected to fetch the greatest demand moving forward along with high-spec jackups. One of the main reasons these companies were chosen for further analysis was due to their level of profitability, and this is directly linked to their fleets' age and corresponding capability. Ensco has by far the oldest fleet of the three companies and that is reflected in the distribution of rig types with only 65% of their current fleet categorized in the top three most attractive rig categories. Meanwhile Seadrill and Atwood have already made the transformation to industry demand with 90% and 100% of their operable fleets categorized in the top three categories.

Based on current rig orders, projecting to the end of 2015, Ensco’s fleet will only have improved marginally. While some might argue that with current speculation swirling about reduced E&P capital spending, Ensco’s more conservative approach is prudent. However, as described in Part I of this series, long-term growth trends for offshore drilling look robust. So, from a fleet make-up perspective, I believe Atwood will end up with the most attractive mix of rigs by end of 2015, with Seadrill second.

In addition to assessing the fleets of each company, I also used the info in the above tables to estimate revenue growth to the end of 2015. The results of those estimates along with my rankings of the fleets can be summarized as follows:

Growth Prospects ESV Rank SDRL Rank ATW Rank
Fleet Status N/A 3 N/A 2 N/A 1
Revenue Growth (DEC-15) 4% 3 45% 1 44% 2
Average   3.0   1.5   1.5

Based on this info, if I had to pick which company has the best growth prospects, my choice would be Atwood. However, it’s really a subjective choice between Atwood and Seadrill because while Seadrill has more scale, Atwood may be more nimble and quick to react to changing demand.

If you recall from the first article of the series, I summarized my investment philosophy with eight criteria. Let’s update the list with what’s been completed thus far:

  1. Understandability.
  2. Growth opportunities.

Financial Health

Financial Health ESV Rank SDRL Rank ATW Rank
Debt-to-Equity 0.4 1 1.8 3 0.7 2
Interest Coverage 11.0 2 4.8 3 17.2 1
Average   1.5   3.0   1.5

Here, I’d give the edge to Ensco. It is much less exposed to a possible downturn in demand and subsequent rig rates.

Profitability

Profitability ESV Rank SDRL Rank ATW Rank
Gross Margin 51% 3 58% 1 54% 2
Operating Margin 36% 2 39% 1 36% 2
Net Margin 29% 1 16% 3 29% 1
ROE% TTM 11% 3 12% 2 15% 1
ROA% TTM 7% 2 4% 3 8% 1
Average   2.2   2.0   1.4

Atwood would look like the obvious choice from a profitability standpoint.

Predictability

Predictability ESV Rank SDRL Rank ATW Rank
8 Year Per Share Revenue R2 0.44 3 0.87 2 0.94 1
8 Year Per Share EBIT R2 0.14 3 0.54 2 0.60 1
8 Year Diluted EPS R2 0.17 3 0.53 1 0.53 1
Average   3.0   1.7   1.0

Note that I like to plot the various metrics (i.e. revenue, EBIT, diluted earnings per share) over time, add a trendline, and then measure the coefficient of determination to act as a proxy for predictability. Among these three companies, Atwood ranks first in predictability.

Management

All three companies have either recently introduced or will introduce new CEOs soon. Ensco’s CEO of eight years, Dan Rabun, is set to retire as soon as a replacement is found. Meanwhile, Seadrill’s Per Wuulf has been on the job for less than a year, having taken over the reigns in July of 2013. Finally, Atwood’s CEO Rob Saltiel has been on the job since December of 2009. With so little track record at the helm of each company it is hard to gauge who has the edge in management; however, as a proxy for management skill, we could instead use the five-year stock performance of the three companies:

Management ESV Rank SDRL Rank ATW Rank
5 Year Stock Performance +88% 3 +342% 1 +190% 2

Valuation

Valuation ESV Rank SDRL Rank ATW Rank
P/B 0.9 1 2.2 3 1.3 2
EV/EBITDA 6.9 1 7.2 2 8.1 3
EV/EBIT 9.0 1 12.8 3 10.1 2
Average   1.0   2.7   2.3

Valuation is difficult to do quickly without accurately projecting the cash flows of each company. The best way would be to use the fleet status reports, booked day rates and historical margins to estimate a three-year return. For sake of simplicity, using comparative valuation methods, Ensco clearly looks the cheapest. However, I think Ensco’s relative cheapness could be misleading because once you factor in the projected growth prospects, the other two companies look better. Which would you rather have, a company trading at an EV/EBIT of 9.0 and projected revenue growth of 4% (over two years) or one trading at a EV/EBIT between 10.1 and 12.8 with projected revenue growth of 40%+ (again, over two years)? Is this cheap enough? The answer to these questions is a matter of taste and risk tolerance.

So the checklist is complete with all items discussed:

  1. Understandability.
  2. Growth opportunities.
  3. Financial health.
  4. High profitability.
  5. Predictable.
  6. Well managed.
  7. Limited downside.
  8. Cheapness.

Before summarizing my findings, let me add one final talking point: dividend yield:

Other ESV Rank SDRL Rank ATW Rank
Projected Dividend Yield 6.2% 2 11.8% 1 0.0% 3

I have mixed feelings about dividends, but it’s hard to ignore them with these three stocks because the discrepancy is so large. Dividends are more a matter of personal opinion and whether an individual believes the payout adds risk to the investment. I tend to prefer stocks with lower yields when the company can reinvest the cash flows at higher rates. I also would rather the company focus on maintaining a healthy balance sheet. Your opinion may vary.

Summary ESV Rank SDRL Rank ATW Rank
1. Understandable Yes Yes Yes
2. Growth Prospects 3.0 1.5 1.5
3. Financial Health 1.5 3.0 1.5
4. Profitability 2.2 2.0 1.4
5. Predictability 3.0 1.7 1.0
6. Management 3.0 1.0 2.0
7. Valuation 1.0 2.7 2.3
Average Overall 2.3 2.0 1.6

For the most part, the summary agrees with my overall view of the three opportunities. I admit to being tempted by the attractiveness of what appears to be a safe dividend yield of nearly 12% offered by Seadrill. I also feel that Ensco is an excellent company and I do appreciate management’s conservative approach. However, at the end of the day, I feel Atwood offers the best mix of risk and reward. Your mileage may vary; which would you choose? I would love to hear your thoughts.

To view Part I, follow the link below:

http://www.gurufocus.com/news/251316

For Part II:

http://www.gurufocus.com/news/251374

Disclosure

At the time of writing, I do not own positions in any of the companies discussed.

About the author:

Kevin Wilde
A happy husband, smitten father, avid value investor and terrible golfer. My philosophy is to purchase the equities of good companies, with good management, at good prices. I believe this strategy minimizes risk while offering significant upside.

Visit Kevin Wilde's Website


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