Ocean Rig (ORIG, Financial), which provides offshore drilling service, has moved higher by 5.4% since the company announced its results on August 5, 2014. This article discusses the strong second-quarter results and why the stock will continue to move higher.
For 2Q14, revenue increased by 69% to $441 million as compared to $260 million in 2Q13. The strong revenue growth was driven by a higher number of operating rigs in 2Q14 as compared to 2Q13 along with a strong rig utilization of 96.3%. During the quarter Ocean Rig Athena successfully completed acceptance testing and commenced drilling operations under the ConocoPhillips (COP) contract in Angola.
The EBITDA growth for 2Q14 was more robust as the EBITDA increased by 100% to $232 million as compared to an EBITDA of $116 million in 2Q13. Another big positive was the company’s EBITDA margin, which expanded by 800bps to 53% in 2Q14 as compared to 45% in 2Q13.
If the current EBITDA is maintained for 2H14, the company’s annual EBITDA is expected to be $870 million. This means that Ocean Rig will be trading at an EV/EBITDA of 7.3 for FY14 as compared to a current EV/EBITDA of 8.7. This is attractive as compared to Seadrill (SDRL, Financial) current EV/EBITDA of 11.7 and an EV/EBITDA of 11.0 for Pacific Drilling (PACD, Financial).
New rig delivery in FY15-FY17 is the factor that will keep the growth momentum strong for Ocean Rig. For 2015, Ocean Rig Apollo is scheduled for delivery in January 2015 and has already been contracted with a current order backlog of $681 million. This will ensure that revenue and EBITDA growth in 2015 is also strong and keep the stock upside momentum.
Even for 3Q14, revenue is likely to be higher than 2Q14 as Ocean Rig Athena was in operation for only 23 days in 2Q14 after deployment into operations. As the rig utilization moves closer to the company’s overall utilization of 97%, revenue for 2H14 will be higher than 1H14.
Overall, Ocean Rig has an order backlog of $4.8 billion, and this is another positive to talk about from a relatively long-term perspective. For 2014, the company fleet is 100% contracted while it is 72% contracted for 2015. A strong order backlog with high profile clients ensures that the revenue inflow is firm over the next few years.
Looking at the balance sheet health, the company’s debt has increased from $3.9 billion in FY13 to $4.4 billion in 2Q14. The increase in debt is not a concern as it is associated with strong EBITDA growth. Considering an annualized EBITDA of $870 million, Ocean Rig has a current leverage of 5.0 and this should not impact the company’s financial health negatively.
The good thing about the company’s debt is that the maturity profile is comfortable. The company’s major debt maturity is expected to come only in 2017 when $832 million of debt is scheduled for maturity. With no immediate debt refinancing pressure and a likely MLP soon, Ocean Rig is comfortably placed from a financial health perspective.
With a free cash flow of $60 million per unit, or a total free cash flow of $540 million for 9 units, the company will also not face any problem in financing the remaining capital expenditure of nearly $2 billion for the remaining new rigs. Therefore, the financial risk is minimal for Ocean Rig.
Another key factor that will help Ocean Rig stock move higher in 2014 and 2015 is the proposed MLP. Seadrill Partners (SDLP, Financial) and Transocean Partners (RIGP, Financial) have already shown that MLP is a good option to enhance valuations. Once Ocean Rig lists the MLP, the company’s debt will also decline and the implied enterprise value per ultra deep-water unit will also increase. The MLP is certainly a key development to watch out for in the near-term.
From a shareholder return perspective, Ocean Rig also declared a dividend of $0.19 per share in 2Q14 and this translates into an annual dividend of $0.76 and a dividend yield of 7.7%. Investors looking for high dividend yield stock can therefore consider Ocean Rig with the company also having earnings stability. Further, with another new rig to be delivered in January 2015, the dividend can be higher for 2015 as compared to 2014. This makes Ocean Rig an attractive dividend option to consider.
In conclusion, Ocean Rig has strong growth coming up and the company’s plan for a MLP is also a positive step towards value creation. Considering all the factors discussed, I believe that Ocean Rig is a good investment. With market valuations stretched, I would consider buying the stock in a staggered manner.
