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Ocean Rig: Growth And Dividends To Continue

May 11, 2014 | About:
Faisal Humayun

Faisal Humayun

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On May 8, 2014, Ocean Rig (ORIG) announced its first quarterly cash dividend of $0.19 per share. At a current stock price of $16.48, the annual dividend yield translates into a healthy 4.6%. This article discusses the reasons for believing that robust growth will continue for Ocean Rig along with strong dividends.

About Ocean Rig

Ocean Rig is an international offshore drilling contractor providing oilfield services for offshore oil and gas exploration, development and production drilling, and specializing in the ultra-deepwater and harsh-environment segment of the offshore drilling industry.

As of May 2014, Ocean Rig had a fleet of nine operating rigs with two rigs scheduled for delivery in January 2015 and December 2015. In terms of fleet composition, Ocean Rig is a pure-play in the ultra deep-water segment with only Pacific Drilling (PACD) having 100% of its fleet in the UDW segment.

Key Investment Positives

Solid Order Backlog

One of the most important factors to consider in the industry is the contract status of the fleet. If the fleet is contracted for long-term with strong counterparties, the revenue visibility is strong. This, in turn, ensures that the dividend payout is stable and sustainable. For Ocean Rig, the order backlog is at a robust $5.4 billion as of March 2014. The current order backlog ensures 99% contract coverage for 2014 and 72% contract coverage for 2015. In other words, the revenue for 2014 is firm and the next three quarters should witness stable revenue along with stable dividend.

Incremental Revenue From New Rigs

While the existing fleet provide stable revenue and cash inflow, the new rigs slated for delivery will provide revenue growth in 2014 and 2015. Ocean Rig Athena has been delivered in March 2014 and is expected to commence operations with Conoco Philips (COP) in the current quarter. It can therefore be expected that the last two quarters of the current year witness incremental revenue growth as the new rig is in operation for the full period.

The revenue growth will be more meaningful in 2015 and 2016 with one new rig for delivery in January 2015 and the other in December 2015. What I want to stress here is that the company has a pipeline of new rigs, which will provide momentum to revenue and EBITDA over the next two years. This will support stock upside and higher dividend payout in the foreseeable future.

Well Placed In The Industry

The key factor for Ocean Rig is differentiation from other players in the industry. Only Ocean Rig and Pacific Drilling have a 100% fleet of ultra deep-water rigs. Ocean Rig’s current fleet size makes it the sixth largest player in the industry and is among the top five players in terms of a modern fleet with an average fleet age of 3.1 years.

This is a positive factor for Ocean Rig in an industry with strong growth potential in the future. Some of the biggest oil discoveries in the recent past have been offshore and the company’s young and UDW fleet ensures that the demand for the rigs will sustain over the long-term.

To underscore my point, the chart below gives the ultra deep-water day rates over the last seven years. It is clear that the rates have remained firm and I do believe that the strong trend will continue.

Healthy Capital Structure

For a capital intensive business, it is always important to look at the capital structure as companies often leverage significantly and fall in the debt trap. For the year ended December 2013, Ocean Rig had a healthy cash position of $659 million.

Further, the company had a total debt of $3.9 billion and a net debt position of $3.3 billion. These metrics translate into a debt to capitalization of 57.3% and a net debt to capitalization of 47.8%. In other words, Ocean Rig has sufficient financial flexibility to fund growth in the future. With the current capitalization status, the financing of $920 million for two new rigs in 2015 will not be a concern.

What is also important to mention in this section is the company’s debt maturity profile. Ocean Rig has $134 million debt maturing in 2014 and $146 million debt maturing in 2015. With minimal debt maturity over the next two years, Ocean Rig is comfortably placed in terms of debt servicing and refinancing. While the company has $646 million of debt maturing in 2016, this should not be a concern as internal cash accruals will be robust.

Risk Factors

There is always a change of delay in the delivery of new rigs. This is one of the risk factors to consider for Ocean Rig with two new rigs expected to be delivered in 2015. Any potential delay in the delivery can impact growth and valuations negatively.

While the industry remains robust, the growth concerns in China need to be watched closely. Sluggish economic growth in 2009-10 had resulted in weakening in day rates as evident from the chart in the industry section of the discussion. Any potential weakening of the offshore drilling market can impact the company’s growth. I do believe that the probability of such an event is low.

Conclusion

Ocean Rig is a specialized player in the ultra deep-water drilling industry. The company has a strong track record in the past and the first ever dividend by the company makes it an even more attractive investment opportunity. As new rigs come into operation over the next two years, incremental revenue and cash flow growth will translate into even higher dividends. Investors can consider exposure to this gem with a initial time horizon of two years.

About the author:

Faisal Humayun
Senior Research Analyst with experience in the field of equity research, credit research, financial modelling and economic research

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