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Invest In This Undervalued Stock With Growing Fleet

April 24, 2014 | About:
Value Investor

Value Investor

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Investors looking to invest in a small cap offshore drilling company which has strong earnings growth, modern fleet and a healthy balance should consider Atwood Oceanics ( NYSE:ATW) as a good investment opportunity. Apart from the above, the company is also trading at a discount to its peers. In this article I will discuss why Atwood Oceanics is undervalued and how the company aims to outperform the market.

Atwood is an offshore drilling company which is engaged in the drilling and completion of exploration and development of wells for oil and gas industry. It consists of four ultra deepwater drillships (three of them are under construction), two ultra-deepwater semisubmersibles, three deepwater semisubmersibles and five high-specification jackups.

Attractive Valuations

Atwood is currently trading at just 6.4 times its forward earnings and 8.3 times its current earnings. Moreover, according to MSN, the company has outperformed the industry earnings estimate. It is expected to do the same with 5 year estimated CAGR of 20.0% earnings growth as compared to Industry average of 18.9%.

Analyst estimates suggest an earnings growth of 29.3% in FY2015. Thus, considering a growth of 29.3%, the PEG 2015 is 0.3, making it attractive as compared to the industry average of 0.5.

What makes the analyst predict a steep earnings growth is the next question to be answered?

Let us look at the drivers which support this bullish stance.

Modern and High Quality Fleet

To gain competitive advantage over peers like Seadrill (SDRL), Transocean (RIG) and Noble Corp, the company has invested $4.5 billion in Ultra deep water floaters and high specification units. These will be delivered in the next 2 years and is estimated to contribute around 80% of the Atwood’s EBITDA in 2015. These “A Class” drillships are expected to provide improved capability, efficiency and safety to the clients. A Class rigs have a better performance characteristics as compared to a typical 5th Gen Drillships. Better performance is thus expected to exceed supply in the coming years.

Source: Company Presentation

Today, Atwood does not have a fleet as young as Pacific Drilling (PACD) or Vantage (VTG). But with the addition of Atwood Achiever, Atwood Admiral and Atwood Archer (due for delivery in 2014 and 2015), It will have one of the most modern fleet in the years to come. These ultra-deepwater rigs are rated to operate in water depths of up to 12,000 feet with enhanced technical capabilities, including two seven-ram BOPs, three 100-ton knuckle boom cranes, a 165-ton active heave “tree-running” knuckle boom crane.

Revenue Visibility

Atwood has a healthy revenue backlog with 95% of the days contracted in 2014, 72% in 2015 and 43% in 2016. As of 1st March 2014 the company has a backlog of $1243 million for FY2015 and $1003 million for FY2016. This would result in an estimated 19% CAGR for the top-line and 15% CAGR for earnings from 2008-2016, thus representing a steady revenue and earnings growth.

This growth is attributed to the company’s strong customer portfolio as well. Since 37% of the company’s customers are major or large NOCs and 34% large independents, stable cash flow is expected thus reducing the downside risk.

Source: Company Presentation

Capital Expenditure Fully Financed

As of 1st March 2014, the company plans to invest $1.5 billion to maintain and improve existing rigs and equipments and purchase and construct newer, higher specification drilling rigs to meet the sophisticated demand of the customers. Expected cash flow of $1.7 billion from operations through 2016 would fully finance the company’s capital expenditure. Therefore, with no meaningful debt addition or equity dilution, shareholders stand to gain from robust operating cash flows.

Conclusion

Increasing demand for higher specification rigs coupled with the addition of newer rigs to the company’s fleet will make Atwood one of the fastest growing companies. Also considering the current undervaluation I would suggest Atwood Oceanics a Strong Buy with a holding period of 2 years as all new vessels come into operation during this period.

About the author:

Value Investor
A value investor.

Rating: 3.0/5 (1 vote)

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Comments

kfh227
Kfh227 premium member - 7 months ago

When does this company expect to turn FCF positive?

They are growing their revs by piling up on long term debt.

At some point, they have to stop growing the fleet and enter maintenance mode. Only at that time will this company maybe turn FCF positive.

Value Investor
Value Investor - 7 months ago

The major capex is lined up for the next two years. I do believe that the company is well managed and as the new drillship come into operation, incremental cash flows will take care of debt servicing, debt and dividends.

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