Rowan Companies (RDC, Financial), which provides offshore oil and gas contract drilling services, has witnessed a correction of 26% in YTD15, but the stock has remained largely sideways since the end of March. Rowan Companies has bottomed out, and these levels are attractive from a long-term investment perspective. This article discusses the factors that make Rowan Companies worth considering in the offshore drilling industry.
The first point that I want to mention is that the Rowan Companies has no new rig commitment as of 2Q15. This is a major positive as the company’s leverage will remain in control and new rig addition is a concern in the current environment where rig contracts are minimal. Companies like Seadrill (SDRL, Financial) and Ensco (ESV, Financial) still have new rig commitments for 2016 and 2017. This is likely to have an impact on their credit health as cash flow outlook remains bleak. In contrast, Rowan Companies has no capital expenditure commitment and the company also has no debt maturity until 2017. This makes Rowan Companies well placed as compared to peers.
The second reason to be bullish on Rowan Companies is the current order backlog. For 1H15, Rowan Companies reported revenue of $1.1 billion and operating cash flow of $449 million. With approximately $900 million in order backlog for 2H15, Rowan Companies is likely to have strong cash flow in FY15. I expect the full-year cash flow to be in the region of $850 million. Importantly, Rowan Companies already has firm order backlog of approximately $1.8 billion for 2016. This implies that the company’s revenue and cash flow in 2016 will remain robust even if there is margin decline as compared to 2015. With $1.8 billion in order backlog, the cash flow in 2016 is also likely to be in the range of $800 to $900 million.
Seadrill mentioned in its 2Q15 report that it expects industry conditions to remain challenging through 2016. Rowan Companies however is well positioned to navigate the challenge with a strong order backlog through the year. Even for 2017, the company’s current backlog is approximately $1.1 billion and I expect the backlog to improve over the next 12-18 months. In all probability, the company’s 2017 revenue and cash flow will be higher as compared to 2016 if broad industry conditions also improve.
With no new rig delivery, the company’s operating cash flow will be used for maintenance capital expenditure along with debt repayment and shareholder returns. Rowan Companies has an annualized cash dividend of $0.4 per share and I see that sustaining through 2016. In addition to operating cash flow, I must add here that the company has $1.5 billion in undrawn credit facility, and this can be used for opportunistic acquisition of rigs or major new rig investment once the market stabilizes.
Besides the point on the company’s strong balance sheet health and robust order backlog, I also like the fact that most of the company’s rigs are premium rigs and a modern fleet is likely to witness strong order intake once industry conditions revive.
Among risk factors, the company’s strong presence in the Middle-East is worth mentioning. The region is in the midst of high geopolitical turmoil and further escalation in tensions can impact the cash flow outlook from rigs in the region. However, I assign low probability of this risk panning out. Low oil prices also remain a risk, and I would be concerned if oil prices fail to trend higher gradually in 2016.
In conclusion, Rowan Companies has a strong balance sheet, robust cash flow outlook, modern rig fleet and no major investments in the foreseeable future. These factors make the company worth considering at current levels. The stock has been sideways in the last few months and it might be an indication of the stock bottoming out. While I still don’t recommend big exposure to the offshore drilling sector, investors can consider small exposure to this potential long-term value creator.
