Paragon Offshore (PGN) is an offshore oil driller spun off from Noble Corp. (NE) in August 2014. Since the spin, shares are off around 85%, significantly worse than its former parent and market overall. While the spinoff significantly decreased the average fleet age of Noble, it left Paragon with a disproportionate amount of debt and an aging fleet. Still, with shares hit significantly, is there enough fear to create a buying opportunity?
The business
Paragon provides offshore contract drilling services to the energy industry around the globe. Customers are oil companies and Paragon’s job is to drill and complete wells. This entails running production casing, stimulation work, and zonal isolation to allow the well to flow hydrocarbons. When contracted, Paragon’s rigs come with a full crew and the equipment and supplies needed to carry out the assigned task, be it one short well or multiple years of work.
Major headwinds created by lower oil prices
Drilling activity is understandably largely driven by the price of the commodity being extracted. At higher prices, oil companies have a higher incentive to drill, creating higher demand for Paragon’s services. With the collapse in oil prices, many operators have significantly pulled back on future capital expenditures for oil projects.
Currently, a significant portion of Paragon’s fleet is unutilized, with a large amount of rig contracts rolling off this year. Predicting future utilization is incredibly difficult without knowing the future price of oil and operators willingness to ramp spend quickly should prices recover.
Additionally, many of Paragon’s major customers have indicated that they will roll-back drilling budgets in the future, specifically Petrobras (35% of backlog).
While both utilization and pricing are expected to be weak, the supply of offshore rigs takes some time to match shifting demand. Even with terrible prospects over the next few years, there is still a significant amount of additional rigs expected to come to market through 2017.
Financial position
Fortunately, Paragon has limited financial obligations, and assuming it does not withdraw any more of its revolver, it should remain solvent through at least 2019.
Additionally, the company is currently cash-flow positive (for now) and sports nearly $60 million in cash on hand.
Valuation
Valuation for Paragon is quite difficult as the company is expected to run losses for the foreseeable future. The crux of any possible investment in Paragon is what you think will happen to oil prices, and how quickly. According to Zack’s Research, analysts are expecting EPS of -$1.02 next year.
A decent barometer for where Paragon would likely trade in a normalized environment is looking at its healthier former parent, Noble Corp. Even at today’s depressed price, Noble still trades at roughly 1x sales. Paragon meanwhile trades at a paltry 0.1x sales. Should the company make it through this difficult environment and be allowed to trade at a normalized multiple, don’t be surprised if it trades closer to Noble’s valuation in the future.
For more ideas like this one, check out GuruFocus’ Spin-Off List or the rest of R. Vanzo’s Articles.
