Dril-Quip (DRQ, Financial), which manufactures, sells and services engineered offshore drilling and production equipment for use in deepwater, harsh environment, and severe service applications, is trading at attractive valuations and can be considered at current levels for long-term exposure. This article discusses the rationale behind this view and the valuation perspective.
I must mention at the onset that Ken Fisher (Trades, Portfolio) of Fisher Asset Management is holding 386,816 shares of the company and Joel Greenblatt (Trades, Portfolio) of Gotham Asset Management is holding 155,288 shares. Therefore, the stock has generated interest from Gurus and considering the attractive valuations, which I will discuss in the article, the stock can generate further interest from hedge fund managers. Investors can track real time fund activity in Guru Focus Real Time Picks.
Coming to Dril-Quip fundamental discussion, the company is a pure play in the offshore market services segment and Dril-Quip has been growing at a steady pace even in difficult times. For FY14, the company revenue increased to $931 million as compared to $872 million in FY13, representing a 6.8% revenue growth. For 1Q15, the company’s revenue increased to $226 million as compared to $204 million in 1Q14, representing a 10.8% revenue growth. The point I am trying to make is that the company’s revenue growth as continued even in the most challenging industry conditions and this has been a result of superior products and service to blue-chip clients.
Past revenue growth is however not a guarantee that the company’s revenue will continue to grow in the future. However, investors can take comfort in the fact that the company’s order book as of March 2015 was $1.1 billion. Therefore, the current order book represents revenue visibility for one year. While the company’s order book has declined from $1.2 billion in FY14, the decline has been due to revenue realisation of $226 million, which also implies that Dril-Quip added orders to the backlog in 1Q15.
Amidst these positive results and continued strength in revenue and EBIT margins, Dril-Quip stock has declined by 12.4% in YTD15 and 35.3% in the last one year. The Peter Lynch earnings line is a clear indication that the stock is undervalued at current levels and a 5-year expected PEG ratio of 0.88 also underscores my point on Dril-Quip being undervalued.
Another big positive about Dril-Quip is that the company’s financial health is excellent. As of March 2015, the company had zero debt and a cash position of $374 million. Further, the company generated $87 million in operating cash flow and this translates into an annualized cash flow of $350 million.
With the company having a maintenance capital expenditure of $30 million on an annual basis, the cash flow is being used to repurchase shares and create incremental shareholder value. In FY14, the company purchased shares worth $200 million and the board has authorized $100 million share repurchase for FY15. The company intends mergers and acquisitions from the cash position in addition to share repurchases. I believe that will add to the company’s value and growth trajectory in the coming years.
I also expect Dril-Quip to start paying dividends at some point of time and that will result in re-rating of the stock and capital appreciation. However, the company might wait for industry conditions to improve before increasing shareholder rewards further.
From an industry perspective, the company’s growth depends on offshore drilling activity and the number of ultra deep-water rigs is likely to increase from 160 in 2014 to 202 by 2016 according the Dril-Quip’s latest presentation. Therefore, the growth opportunity is significant, but I would remain slightly cautious as lower oil prices on a sustained basis can meaningfully impact offshore drilling activity that has relatively higher break-even.
While Dril-Quip’s order book ensures good revenue visibility for the next 12-15 months (from March 2015), investors need to check for order intake in the coming quarters. Even with this risk factor, the stock is worth accumulating and I mentioned this risk to back my point that gradual accumulation of this stock is advisable than taking a big plunge.
In conclusion, strong order backlog, quality service to clients and an excellent balance sheet are most important factors to consider Dril-Quip. The stock can potentially move sideways in the near-term, but the long-term growth story is promising.
