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North Atlantic Drilling: Strong Revenue Visibility and Growth Prospects

June 11, 2014 | About:
Faisal Humayun

Faisal Humayun

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North Atlantic Drilling (NADL), which is Seadrill’s (SDRL) dedicated vehicle for harsh environment and Arctic operations, is a potential long-term value creator. This article discusses some of the investment positives and the potential risk factors for the company.

High Revenue Visibility

As of March 2014, North Atlantic Drilling had a contract backlog of $2.4 billion from tier one oil companies as shown below. The contract backlog of $2.4 billion gives the company a 1.8 times revenue visibility based on fiscal 2013 revenue of $1.3 billion.

Given the current contract status, the company’s fleet is 99% contracted for 2014, 76% contracted for 2015 and 51% contracted for 2016. This implies that the company nearly has two years of firm cash inflow visibility. Potential revenue inflow from strong counterparties as shown above ensures that the cash inflow is secure.

For the long term, the factor that sets North Atlantic Drilling apart from other companies is the fact that it is a pure-play in the harsh water environment. With high offshore drilling activity in the North Atlantic and Arctic region, the revenue visibility will remain firm for North Atlantic Drilling.

High Dividend Payout

For the first quarter of 2014, North Atlantic Drilling announced a quarterly dividend of $0.24, an increase of $0.01 as compared to the prior quarter. Even if the dividend remains stable for the rest of the quarters, the company is currently offering a dividend yield of 8.7%.

This is very attractive considering that the company has a firm revenue outlook for the next two years with additional growth slated to come from one new rig delivery. I do believe that the company will gradually increase its dividend payout and North Atlantic Drilling is well-positioned to be a quality dividend stock.

Partnership with Rosneft

In May 2014, North Atlantic Drilling and Seadrill signed an agreement with Rosneft to pursue growth opportunities offshore and onshore in the Russian market through at least 2022. This partnership can be a game changer for North Atlantic Drilling as it provides the company with an entry in a market with tremendous growth potential.

The Arctic region is estimated to have over 400 billion barrels of oil equivalent with 85% of the resources expected to be offshore. Further, 50% of the resources are expected to be in Russia and this makes the region one of the best in terms of potential growth for offshore rig companies.

North Atlantic Drilling has already been contracted to drill the first two wells in the Kara Sea, as part of Rosneft and Exxon's joint venture during 2014 and 2015. The agreement envisions initial employment of up to nine offshore rigs to Rosneft with a total commitment of 35 rig years.

Should this happen, North Atlantic Drilling will have multiple years of firm revenue visibility. Closing of the transaction is expected during the second half of 2014, and the next few years should see strong order inflow for the company from the agreement.

Strong Financial Position

Another positive factor for North Atlantic Drilling is its robust financial position. Discussing the financial was important as the company has nearly $2.5 billion of debt as of first quarter 2014 and the debt servicing metrics need to be checked for concluding on a sound financial position.

Considering an EBITDA of $119 million for the first quarter and an annualized EBITDA of $476 million, North Atlantic Drilling is currently trading at a leverage of 5.2.

This is certainly not a concern with the EBITDA interest coverage at 2.5. The company is therefore in a comfortable position to service its debt. Further, with firm cash inflow visibility, the company’s debt servicing position is expected to remain comfortable.

Therefore, from a balance sheet perspective, North Atlantic Drilling is well positioned with financial flexibility to fund its growth.

Risk Factors

While the partnership with Rosneft can be a game changer, the political uncertainly risk is high in the region. Any escalation of tension related to Russia and Ukraine can have a negative impact on the planned growth in the region.

The global oil prices determine the offshore drilling activity to a large extent. One of the key risks in the global economy is the direction of growth in China. Continued sluggish growth can negatively impact oil prices. However, China’s growth might have bottomed out in all probability and the probability of this risk playing out is low.

Conclusion

North Atlantic Drilling is well positioned to grow at a robust pace with a strong order backlog and a promising partnership with Rosneft. Besides the growth potential, the company also offers a very attractive dividend yield, which is likely to remain. While high debt seems like a concern, the company has strong cash flows to service the debt. Investors can consider the stock at current levels and on any broad-based market correction.

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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