Vantage Drilling (VTG) is an offshore drilling contractor which operates and manages a fleet of modern, high specification drilling rigs. As of March 2014, Vantage Drilling has a fleet of four jack-ups and three drillships with another drillship under construction. This article discusses the reasons to be bullish on this small-cap with a medium to long-term investment horizon.
Strong Order Backlog
Vantage Drilling has witnessed revenue growth from $112 million in 2009 to $732 million in 2013. While the past is good, in this analysis, it is more important to look at the factors that will contribute to revenue growth in the future.
As of December 2013, Vantage Drilling had an order backlog of $2.8 billion, which gives the company a four-year revenue visibility based on fiscal 2013 revenues. Further, the contract is with strong clients globally such as ONGC, Total and Petrobras among others. This ensures that the cash inflow prospects are firm.
A strong order book implies that Vantage Drilling will continue to grow at a robust pace in the foreseeable future. The company’s ultra-deepwater fleet is contracted through 2015 and the jack-up fleet is 98% contracted for 2014 and 30% contracted for 2015. This effectively means that the company will have a strong 2014. Further, 2015 will also remain strong as it is likely that the jack-ups will be contracted in a relatively good market condition. Vantage Drilling’s growth story will therefore remain intact.
Delivery of Cobalt Explorer in 2015
Another significant event for the company, which will have a strong impact on the stock price going forward, is the potential delivery of Cobalt Explorer by the end of 2015. Cobalt Explorer will be the company’s most technically advanced drillship and can command significantly higher day rates than the existing drillships.
While the drillship will not have any revenue impact in 2015 as it is expected to be delivered by the end of 2015, the impact on revenue in 2016 will be significant. The potential upside in revenue in 2016 can be $250 million just with the addition of Cobalt Explorer.
The important point here is that the revenue growth seen in the past is likely to sustain on the back of firm orders and delivery of a new drillship. This is true for the period 2014 to 2016.
To add to the positives, Vantage Drilling is trading at a valuation, which is at a discount to peers. Therefore, a high growth entity is available at attractive valuations. Currently, Vantage Drilling has an EV/EBITDA of 9.3. This looks attractive when it is compared with similar companies such as Pacific Drilling (PACD) with an EV/EBITDA of 12.7 and Ocean Rig (ORIG) with an EV/EBITDA of 10.5.
Considering the fact that the revenue outlook for 2014 is firm, the valuation will remain attractive and it is very likely that Vantage Drilling’s valuation catches up with its peers at some point of time in 2014. Therefore, the case for an upside potential is strong and investors can consider exposure to the small-cap at these levels.
No Debt Maturity Burden
Vantage Drilling has a total debt of $2.9 billion as of December 2013. This might look significant for a company with a market capitalization $506 million.
However, on drilling deeper into details, the debt maturity profile shows that the company has no meaningful debt maturity until 2017 when $400 million of debt matures. As per the company’s guidance, the cash flow from operations will be sufficient to cover for all debt service through 2018.
The big debt of $2.9 billion is therefore not a matter of concern and the leverage has helped the company rapidly expand its fleet, which will generate strong cash flows in the foreseeable future.
From an equity holder’s perspective, Vantage Drilling expects that the company’s return of capital employed will increase from 8% in 2013 to 11% in 2014. This will be a positive development and the 2014 expected ROCE will better the ROCE of larger players such as Seadrill (SDRL), Transocean (RIG) and Ensco (ESV). Vantage Drilling therefore has better things in store for shareholders in the medium-term.
Vantage Drilling looks attractive from a valuation perspective and is among the few stocks, which are undervalued at a time when the overall equity markets are touching record highs. The downside risk for Vantage Drilling might therefore be limited while the upside growth potential is very significant.
The revenue growth in 2014 and 2016 is expected to be strong and this should be associated with an increasing EBITDA growth. Investors can consider Vantage Drilling with a one to two-year initial time horizon. The small-cap has the potential to make it big and if this does turn out to be true, the returns can be phenomenal.