Among offshore drilling stocks, Noble Corporation (NE, Financial) has quality assets and a strong balance sheet to survive the crisis. The stock has, however, seen some sharp correction recently and declined by 42% in the last six months.
While the correction is overdone, it is important to investigate if Noble Corporation can sustain dividends at $30 to $35 in the oil price environment. Due to the recent correction, Noble Corporation offers a dividend yield of 14.01%, and it seems unsustainable considering the broad market conditions. However, a discussion from a financial perspective is needed to reject or accept the likelihood of dividend suspension.
If I had to make a case for dividends to sustain through 2016, the following points would be my support rationale – Noble Corporation has an order backlog of $2.5 billion for 2016, and this implies operating cash flow of approximately $1.0 billion.
Further, Noble Corporation has a planned capital expenditure of $800 million in 2016 for delivery of one rig, and this would imply that the company is free cash flow positive. This argument still holds up, but the markets will start looking beyond 2016 because oil prices have shown no signs of recovery. Instead, big brokerages are predicting that oil might slump to $20 per barrel sometime in 2016.
Therefore, my first point is that Noble Corporation is likely to have positive FCF in 2016, and that’s a credit positive. However, when the company is making a decision related to dividends, the management will be looking beyond 2016. In the current scenario, slow recovery in the offshore drilling industry (best case) seems likely for 2017. If this assumption holds true, the management will consider conserving cash rather than paying out generous dividends.
The second point to note is that Noble Corporation’s order backlog is $1.6 billion for 2017. If I assume that industry recovery will be gradual in 2017, I don’t expect 2017 backlog to be higher than 2016. Further, new contracts will have significantly lower day rates, and this would imply that the company’s EBITDA margin and cash flow potential shrinks in 2017. This factor might be the trigger for Noble Corporation management to consider reducing or suspending dividends in the next few months. At the same time, the stock has largely discounted this factor.
Still, from an investment perspective, the question remains if Noble Corporation can be considered at current levels. There are major concerns related to China, and this impacts the demand (consumption) side equation for oil. Therefore, until there is more clarity on the real GDP outlook, wait and watch. Further, even if the dividend reduction factor is discounted, stocks tend to react negatively to any such news. I would rather be a buyer on negative news than a buyer at this point.
From a risk perspective, 11.2% of the company’s order backlog is from Freeport-McMoRan (FCX, Financial). The stock has taken a beating, and significant capital expenditure cuts for 2016 and 2017 can be expected in order to conserve cash and prevent further leveraging. Potential contract cancellation looms, and that is a risk going well into 2016 if oil remains depressed.
I don’t see any balance sheet-related risk (debt to capitalization of 37%) for Noble Corporation through 2016 and into 2017. If oil prices remain weak, dividend suspension will serve as a source of liquidity buffer that will help the company sustain for at least the next 24 months.
Noble Corporation is a good stock, but wait for more clarity on China and further direction in oil prices before considering any exposure to the stock. Even long-term investors should remain on the sidelines and wait for a few negative triggers to play out before considering any positions.
Disclosure: No positions in the stock.
