Among the offshore drilling services stocks that I have been closely tracking in the last 12 months, Rowan Companies (RDC, Financial) finds a place, having strong fundamentals and robust revenue visibility.
The company’s third-quarter results and key positives make me believe the stock can trend higher in the near to medium term.
The first point is that Rowan Companies reported cash and equivalents of $1.0 billion for the third quarter. Considering total debt of $2.7 billion for the same period, the net debt is just at $1.6 billion and a strong balance sheet is one of the key reasons to be bullish on the stock.
An important point to note is that Rowan Companies has $358 million in debt maturity in 2017 and $397 million in debt maturity in 2019. Using the current cash buffer, the company can repay the debt that is due in the next few years. I do expect Rowan Companies to deleverage in the foreseeable future and that will improve the company’s fundamentals at a time when the industry is struggling.
The second point worth noting is that Rowan Companies reported operating cash flow of $689 million for the first nine months of the year. During the same period, the company reported capital expenditure of $89 million. The free cash flow has been robust at $600 million at a time when companies in the offshore drilling industry are still struggling with new rig deliveries and their payments.
In particular, Seadrill (SDRL, Financial) has significant leverage and still has new rig deliveries that the company has been postponing. Having no speculative new rig delivery, Rowan Companies has set itself apart from several companies in the industry.
Rowan Companies also has $1.5 billion in undrawn credit facility that adds to the liquidity buffer. While the cash can be potentially deployed to reduce debt, Rowan Companies is well positioned for some strategic rig purchase if industry conditions improve. In 2017, I do expect some distress sale of assets and Rowan Companies is well positioned to acquire assets at an attractive valuation.
The next point is the company’s order backlog for the fourth quarter and fiscal 217. For the fourth quarter, Rowan Companies has a backlog of $272 million with a decent order backlog of $1.1 billion for 2017. The backlog sharply declines to $460 million in 2018, but I expect new contracts to flow in the next 15 months.
For the remainder of 2016 and for fiscal 2017, a total order backlog of approximately $1.4 billion can potentially ensure an EBITDA of $500 million to $550 million. EBITDA will be decent in the next 15 months for debt servicing, and free cash flow will add to the liquidity buffer. I don’t see any credit-related concerns for the company in the medium term. I would be concerned if industry conditions fail to improve even through 2017. However, that seems unlikely as I expect oil to trend higher in the coming year.
A common concern for the offshore drilling services industry is the potential EBITDA margin compression that’s likely on new contracts. However, the factor has been discounted in the stocks based on the day rate trend.
From a stock price perspective, Rowan Companies touched a high of $19.55 in June, and the stock has subsequently been in correction mode. I see current levels of $13.8 as an attractive entry point for medium-term investors. If oil continues to trend higher in 2017, Rowan Companies is likely to provide stellar returns.
Disclosure: No positions in the stock.
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