Pacific Drilling (PACD) is an offshore drilling contractor with five rigs in operation and three rigs to be delivered in 2014 and 2015. Further, as of first quarter 2014, Pacific Drilling had six contracts and a contract backlog of $3.1 billion. This article discusses the reasons for being positive on the stock in 2014 and also for the long term.
One of the biggest positives for Pacific Drilling is the age and technical specification of its fleet. As the chart below shows, Pacific drilling has one of the most modern fleet in the industry, closely followed by Vantage Drilling (VTG).
The importance of having a younger and technologically advanced fleet is clear by looking at the second chart below.
The chart gives the day rate for floating rigs according to the rig age. In the recent past, the older rigs (marked in red) have commanded a much lower day rate as compared to the younger rigs in the industry. Therefore, E&P companies prefer modern rigs with better specifications and better safety standards. This is where Pacific Drilling stands to gain compared to other players in the industry such as Diamond Offshore (DO), Transocean (RIG) and Enesco (ESV).
Robust Contract Backlog
Pacific Drilling has one of the best contract coverages as a percentage of days available for 2014 and 2015. For 2014, Pacific Drilling is 99% contracted and is 68% contracted for 2015. This is only second best to Ocean Rig (ORIG), which has contract coverage of 99% and 76% for 2014 and 2015, respectively.
With 99% coverage for 2014, there is a firm revenue visibility and it is very likely that the contract coverage for 2015 will improve as two new deliveries are contracted during the course of the year. It most important to mention that there will be significant incremental impact on revenue in 2014 and 2015, which will come from the delivery of Pacific Sharav in second quarter 2014, Pacific Meltem in third quarter 2014 and Pacific Zonda in the first quarter of 2015.
Strong Revenue, EBITDA and Cash Flow Growth
As new rigs are delivered in 2014 and 2015, Pacific Drilling will witness robust growth in revenue and operating margin along with growth in operating cash flow. Given the day rates for the contracted fleet above and assuming that the two un-contracted rigs are contracted at the rate Pacific Sharav got from Chevron (CVX), it is likely that Pacific Drilling will witness revenue growth in the region of 60% to 70% for 2014 as compared to 2013.
The momentum in 2015 is likely to continue with the delivery of another rig in the first quarter of 2015. Again, if the new rig is contracted at a day rate higher than $500,000, the revenue growth in 2015 can potentially be in the range of 35% to 40%. Therefore, Pacific Drilling is set for big growth in 2014 and 2015. As the chart below shows, consensus EBITDA estimates suggest that Pacific Drilling will have an EBITDA growth at a CAGR of 52% between 2013 and 2015.
In terms of operating cash flow, the outlook is equally positive and the company expects the cash flow to improve from $230 million in 2013 to $350 million in 2014 and $600 million in 2015. Therefore, strong cash inflows are expected over the next two years. This should provide an upside trigger for the stock.
One of the major positives amid robust growth for Pacific Drilling is excellence and efficiency at the operating level. To put things into perspective, Pacific Drilling has witnessed an improvement in EBITDA margin from 36.7% in first quarter 2012 to 48.0% in fourth quarter 2013. During the same period, the operating expense per rig has naturally declined from $185,600 per day to $176,200 per day. These numbers speak volumes about a well-managed entity.
Comfortable Debt Position
One of the issues associated with high growth can potentially be high leverage. Pacific Drilling has done well to sustain growth and keep leverage within manageable limits. For the year ended December 2013, Pacific Drilling had a total debt outstanding of $2.43 billion. While the debt to EBITDA of 6.8 might suggest relatively high leverage, the company is in a comfortable position to service debt and the principal with an extended maturity profile.
With the exception of $300 million of debt maturing in February 2015, all the other debt is due on and after December 2017. As mentioned earlier, Pacific Drilling will be generating operating cash flow of nearly $600 million by 2015. Therefore, the company will be well positioned by 2017 to repay the debt through internal accruals. Debt refinancing will also not be an issue for a fundamentally strong company with robust operating cash flows.
Pacific Drilling will have one of the most advanced set of rigs by the first quarter of 2015, when all the new rigs are delivered. The six contracted rigs already have a robust order backlog of $3.1 billion, which is expected to swell further as two new rigs get contracted at some point of time in 2014. Consensus estimates peg EBITDA growth for Pacific Drilling as the best in the industry. With all these positives and a current stock price of $10 (EV/EBITDA of 12.06), I expect Pacific Drilling to outperform in 2014 and 2015. Investors can consider exposure to this high growth stock with a two-year time horizon.