Pacific Drilling (PACD, Financial), which provides ultra-deepwater drilling services to the oil and natural gas industry has corrected by 34% in 2014 as a result of difficult times for the offshore drilling industry. Pacific Drilling is not the only stock to take a beating, even Ocean Rig (ORIG, Financial) has corrected by 32% in 2014 and Seadrill (SDRL, Financial) has corrected by 43%.
Seadrill has a larger set of problems as compared to Ocean Rig and Pacific Drilling at this point of time. This article looks at why Pacific Drilling is looking interesting after a 34% correction and can be considered for the long-term.
The first reason to be bullish on Pacific Drilling is the company’s fleet. Pacific Drilling has 100% of its fleet as high specification ultra deep-water fleet as compared to 84% for Ocean Rig. A modern fleet means that the company has an edge over peers when the offshore drilling market recovers. Currently, decline in oil prices is a major concern for the offshore drillers. However, I believe that oil prices will bounce back soon as global geo-political tensions are oil price supportive.
Another positive factor for Pacific Drilling is that the company has 100% of available days contracted in 2014 and 69% of available days contracted in 2015. This means that the company’s cash flow and growth is unlikely to be impacted in 2014.
Further, it is probable that the company’s contract coverage for 2015 is boosted over the next few months. Pacific Drilling is ahead of Seadrill in terms of days available that are contracted in 2014. Seadrill has 89% days contracted in 2014 and 74% days contracted in 2015.
The big challenge for Pacific Drilling will be getting the contracts for two new vessels that are scheduled for delivery in the third quarter of 2014 and in the first quarter of 2015. I believe that both the vessels are likely to be contracted primarily because of the modern fleet. However, the vessels will not command a high day rate as the existing feet commands.
According to Pacific Drilling, the company is expecting operating cash flow of $365 million in 2014 and a cash flow of $535 million in 2015. While the cash flow outlook for 2014 is firm, the cash flow for 2015 can be negatively impacted if there is a delay in contracts for the two new vessels. Even if the estimates are lowered, Pacific Drilling will see robust cash flow growth in 2015 as compared to 2014.
On looking at the valuations, Pacific Drilling is currently trading at an EV/EBITDA of 9.77 as compared to an EV/EBITDA of 9.44 for Seadrill.
I believe that Pacific Drilling can command some premium over Seadrill at this point of time due to a relatively modern fleet and due to relatively less concerns related to leverage. Seadrill’s Rosneft deal also looks uncertain due to the sanctions on Russia. Amidst all these concerns for Seadrill, Pacific Drilling looks relatively better for exposure.
The key point is that when markets recover, Pacific Drilling will have a fleet of eight modern ultra deep-water vessels to drive growth. There is no doubt that Seadrill is a much larger organization, but Seadrill has been reeling under debt pressure along with a key management exit.
From a debt perspective, Pacific Drilling has a $300 million unsecured note maturing in February 2015. Post that debt maturity, the company’s debt maturity will come only on December 2017.
The current operating cash flow in excess of $300 million is more than comfortable to service the debt and the offshore markets are likely to recover well before December 2017. Therefore, the current debt is not a matter of concern for Pacific Drilling.
Investors can therefore consider Pacific Drilling as a good stock to buy at current levels. In my opinion, investors should go slowly on accumulating the stock as the broader markets can correct further and individual stocks can correct due to broader market negative sentiments.
Pacific Drilling has a relatively high beta of 1.77 and that is one risk factor that needs to be considered in these volatile markets. However, taking into account the broader picture, Pacific Drilling is certainly a buy and if the stock moves more interesting levels, the stock will be a strong buy.
