I discussed Rowan Companies (RDC, Financial) as one of the quality names in the offshore drilling industry when sentiments were bearish for the stock and industry. The stock has delivered 53% returns in the last four months and has been marginally lower to sideways recently.
There is significant long-term upside potential that remains in the stock.
Rowan Companies announced  on Nov. 21, 2016 a joint venture with Saudi Aramco to own, operate and manage offshore drilling rigs in Saudi Arabia. The 50-50 joint venture is expected to commence operations from second-quarter 2017; at the commencement, Rowan Companies will contribute three of its jack-up drilling rigs, and Saudi Aramco will contribute two of its jack-up drilling rigs. Rowan Companies will contribute an additional two jack-up rigs as it completes its current Saudi Aramco contracts in late 2018. The new company will manage Rowan’s existing rigs until current contracts expire, when the new company will lease the rigs from Rowan Companies as needed.
While this is just an overview of how the contract with work initially, the key point to note is that the association with Saudi Aramco will ensure that long-term orders swell for Rowan Companies in the next few years. Just to put things into perspective, the new company plans to order at least 20 rigs beginning 2021. This might be a few years away, but the long-term association is likely to be a cash spinner for Rowan Companies.
Further, the joint venture might accelerate the new rig orders and delivery based on how oil prices move in the coming 12 to 24 months. If oil does continue to trend higher during this period, Saudi Aramco is likely to see more demand for rigs that will be potentially serviced through this joint venture. Therefore, the JV is critical and does improve sentiments for Rowan Companies. It is worth noting here that even after a big upside in the recent past, Rowan Companies stock has remained resilient. I see current levels as appealing for investors considering the stock with a three- to five-year investment horizon.
Rowan Companies' stand-alone and the fundamentals is another reason to be bullish on the stock. The few specific points related to the fundamentals are as follows:
- Rowan Companies has no speculative new rigs for delivery and with capital expenditure of just $100 million for 2017, the company will generate positive FCF that can be deployed for further deleveraging or creating cash buffer for future investments.
- Rowan Companies has current cash balance in excess of $1.2 billion, and it’s important to note that the company has retired debt worth $650 million since fourth-quarter 2015 through open market and tender purchases. The new debt issued has extended the debt maturity profile, boosting fundamentals.
- Rowan Companies currently has an order backlog of $2.2 billion; at least for 2017, the backlog is decent. With firm backlog and improving market conditions, I expect healthy EBITDA for 2017. Considering the company’s interest expense estimate of $150 million for fiscal 2017, I don’t see debt servicing as a concern.
Besides these fundamental factors, Rowan Companies has mentioned in its latest presentation that the company will be seeking opportunistic acquisition of assets. Considering the strong cash buffer coupled with undrawn credit facility available with the company, I do expect inorganic growth if the industry's recovery continues. It is important to note that several offshore drilling companies are loaded with debt and might pursue asset sales. This will provide a good opportunity for Rowan Companies to buy quality assets at an attractive price.
Rowan Companies is a stock worth considering for the medium to long term, and I am bullish even after the big upside in the recent past. When oil was at depressed levels, offshore exploration companies worked on lowering offshore costs; as break-even levels decline on a relative basis, the industry recovery can be potentially faster. If oil does trend above $60 per barrel in the second half of 2017, offshore drillers will have more reasons to surge higher.
Disclosure: No positions in the stock.
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