As oil moved higher on news of production cuts by OPEC, there was hope for offshore drilling stocks and many stocks reacted positively by surging higher. Atwood Oceanics (ATW, Financial) has been among the offshore drilling stocks that have outperformed in the last two months with the stock surging 82% during this period. Does Atwood Oceanics still have juice in the current rally or should investors wait for correction before fresh exposure to the stock?
Atwood Oceanics announced on Monday a public offering of 13.5 million common shares with the underwriters having an option to purchase an additional two million shares. This implies equity dilution of approximately 24%.
The company intends to use the proceeds of the equity offering for general corporate purposes, including the repayment of borrowings under its credit facility, the funding of future purchases of outstanding 6.5% senior notes due in 2020 and liquidity buffer for other operational purposes in the foreseeable future.
This is important because the big equity dilution implies the stock is headed lower in the near term and I would therefore suggest investors remain on the sidelines. With this near-term view, I will focus on the medium-term outlook. This will help investors judge if the stock is worth considering after potential correction in the coming weeks.
Starting with the positives, Atwood Oceanics has one of the most modern fleets in the industry with an average fleet age of 5.5 years. If industry conditions improve significantly in the near future, this factor will certainly work in the company's favor. But I do see U-shaped recovery for the industry, which implies challenging conditions sustaining from a fleet recontracting perspective.
Another key positive for Atwood Oceanics is the fact the company has worked well on cost control with onshore support cash costs declining from $95 million in 2015 to $75 million in 2016. For 2017, the cash cost is likely to decline further to $65 million. At the same time, rig operating cash costs have declined on a sustained basis and will continue to decline in fiscal 2017. Coming out of the crisis, I expect Atwood Oceanics to be much better from a cost management perspective and whenever day rates for rigs start trending higher again, the EBITDA margin will be worth watching.
The company’s liquidity position also looks better with $155 million in cash and $545 million in available credit facility as of December 2016. According to Atwood Oceanics, the company intends to close 2017 with a liquidity buffer of $762 million considering the operating cash flow and key expenses (capital expenditure and debt service). This does not include the recent liquidity inflow that is expected from the issue of common shares.
Atwood Oceanics reduced debt to $1.2 billion from $1.7 billion in fiscal 2016. With the common share issue to further reduce debt, the company is doing well on the deleveraging front. The company has also amended the retained cash flow to relax covenants providing access to funds in the medium term.
With all these positives, there are reasons to remain optimistic about Atwood Oceanics. However, I would remain cautious for the following critical reasons:
- The announced equity offering will translate into near-term downside as discussed above.
- There are several rigs going off contract through 2017 and it remains to be seen if these rigs get immediate contracts even with gradual recovery in the industry. Further, it also remains to be seen if the contacts come at a decent day rate and the EBITDA margin remains healthy.
With this key point in consideration, I would wait for the next few months to see if there is increased activity in the offshore industry. I do not expect the stock to see renewed momentum anytime soon. After equity dilution and the waiting period, investors will discover how quickly the industry is responding to oil price recovery. For now, it would be best to remain on the sidelines.
Disclosure: No positions in the stock.
Start a free 7-day trial of Premium Membership to GuruFocus.
