Today's Buy Opportunity: Noble

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Now, I know what you're thinking: "You're pitching me a drilling contractor? Are you crazy?! Do you even watch the news?" Before I get into why Noble (NYSE: NE  ) is today's "11 O'Clock Stock" and a great investment, let's address your concerns.

The fiasco in the Gulf of Mexico, now our nation's largest natural disaster, appears to have been preventable. Rex Tillerson, ExxonMobil's (NYSE: XOM  ) CEO, said as much in front of Congress last month. However, Big Oil is only as good as its worst operator, and BP may well have been the worst. The British giant had a whopping 760 safety and environmental violations since 2005. To put that in perspective, Exxon only had one.

In the wake of BP's bad behavior, we're left with a drilling moratorium in the Gulf and a lot of uncertainty surrounding the sector. Shares of oil services companies have been beaten down far in excess of the market. And like another great investor who proclaimed that we need to "be greedy when others are fearful" (hint: Warren Buffett), it's time to get greedy on offshore drilling. Noble offers the best way to do so.

Fast facts on Noble:

Market Capitalization

$8.1 billion

Industry

Oil & Gas Drilling

Revenue (TTM)

$3.4 billion

Earnings (TTM)

$1.46 billion

Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

Getting better acquainted
Founded in 1921, Noble relocated to Switzerland for tax reasons last year. The company makes its money by drilling wells, via its 62 mobile offshore rigs, for oil companies across the globe. Currently, its most exciting destination is Brazil, where a bonanza of recently discovered oil has made Petrobras (NYSE: PBR  ) , the Brazilian state oil company, Noble's biggest client.

Noble contracts its units out from periods of several months to more than five years, but for easy comparisons, the industry breaks the contracts down to a figure called the dayrate -- the price per day to operate the rig. To give you an example of the premium that deepwater-capable units command over shallower-water jack-up rigs, Exxon has four of Noble's jack-ups in use in Nigeria at roughly $85,000 a day. At the same time, a semisubmersible hired by the oil giant in Libya is contracted at a price in excess of $500,000 a day.

Show us what you're made of
Let's take a look at how some of the industry's top competitors stack up. The table shows key financial metrics, while the chart shows the breakdown of each company's fleet by number of rigs, both financially and on a fleet basis. Keep in mind that Noble's data predates the completion of the Frontier Drilling purchase; I'll touch on that a little later.

Company

Market Cap
(in billions)

Net Debt
(in millions)

Operating
Margin

PEG Ratio

Transocean (NYSE: RIG  )

14.48

9,855

37.6%

0.69

Diamond Offshore (NYSE: DO  )

8.57

719.7

48.6%

0.52

Noble

8.14

-332.1

50.3%

0.71

Ensco (NYSE: ESV  )

5.98

-971.3

40.6%

1.46

Data from Capital IQ and Yahoo! Finance as of 07/25/10.

Data from company rig reports. Water depth is deepwater = > 4,500 ft, midwater = 401-4,499 ft, shallow water = < 400 ft.

As you can see, Transocean is clearly the largest player, both in terms of market cap and sheer fleet size. Its 135 rigs nearly equal the fleets of other three companies combined. However, it has also rung up a massive debt load in the process, and its operating margin is lagging. Additionally, the financial and reputational fallout stemming from its involvement in the Deepwater Horizon disaster will take some time to get sorted out.

Diamond just edges out Noble as the second-most-valuable company in the industry, and its balanced fleet is certainly an asset. Even though a quarter smaller, it manages to bring in revenue comparable to Noble thanks to its favorable mid- and deepwater mix. However, not only is its balance sheet is disconcerting, but Diamond is also trading at 2.4 times its book value, while its competitors are hovering right around 1 times book value, ruling it out as the group's value play.

I like Ensco, especially for its stellar balance sheet, where its net cash balance of nearly $1 billion manages to trump Noble. However, Ensco's growth prospects are not considered as strong as the rest of the group: It is trading at a higher earnings premium, and its heavy dependence on jack-up rigs with the lower day rates is a turn-off.

The winner!
I favor Noble because it has the top operating margin, attractive financial ratios, and good exposure to the deepwater, which will only get better when it completes its purchase of Frontier Drilling.

Click here to see a video of a Fool.com analyst discussing why Noble's a great buy.

The $2.16 billion deal, which closed yesterday, increased Noble's fleet count to 69. Not only are these great vessels, but two of them are jointly owned with Shell, while two more carry valuable long-term contracts with the oil major. Noble wisely used its fiscal prudence to be aggressive at the bottom part of the cycle. A $1.25 billion debt offering will mostly wipe out its strong net cash position. However, that the deal instantly doubled Noble's backlog, should be immediately accretive to cash flow, and will add $0.35 to Noble's per-share bottom line by 2011.

Noble may not be the highest flier, but I believe there is a fairly safe 15%-20% upside based on a conservative multiple, with greater potential down the road as the Frontier purchase kicks in, coupled with what I expect to be rising oil prices.

What could possibly go wrong?
When you're in a commodity-based business, the underlying price of that commodity is your biggest risk. If oil prices tumbled significantly, Noble wouldn't be able to charge its current high dayrates, which would have a material impact on its financial performance. However, if you believe that once the global economy fully recovers, oil will break out of its $70-ish-a-barrel trading range and resume its march higher, then Noble will benefit.

The Gulf moratorium is also a concern. Anadarko Petroleum (NYSE: APC  ) has declared force majeure on Noble, and it is likely that the company will feel the moratorium's financial impact for a couple of quarters.

However, we are still seeing activity. Ensco managed to talk regulators into giving two of its deepwater rigs the thumbs-up for use on certain types of projects. Diamond Offshore has moved rigs from the Gulf of Mexico to Africa and the Middle East.

But that's the important point: Even if rigs are fleeing the Gulf, they're going somewhere. Noble can move its affected semisubs to other regions if it receives a different finger from the government than Ensco did.

Foolish takeaway
The world's insatiable appetite for oil is only growing. China just passed the United States as the largest global energy consumer, but they still trail dramatically on a per-capita basis. Even though the Gulf of Mexico blowout highlighted the risks, and potentially how unprepared the industry was for a catastrophic disaster, offshore drilling and deepwater drilling are here to stay. We aren't going to wean ourselves off oil overnight, and as E&P's are forced into deeper waters to satisfy our needs, Noble will be there, charging a premium for use of its rigs.

Previous recommendations

Come back to Fool.com tomorrow for another great stock pick. There's plenty more great stock advice, and you can find video of each day's recommendation as well! To see the performance of previous recommendations, click here.

"11 O'Clock Stock" is sponsored by Motley Fool Stock Advisor. The Motley Fool will wait at least 24 hours after this publication before purchasing shares of Diageo. Got questions? See our "11 O'Clock Stock" FAQ.

David Williamson owns shares of BP. Petroleo Brasileiro is a Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool's disclosure policy is happy that the majestic Gulf Walrus is OK.


Read/Post Comments (10) | Recommend This Article (55)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 29, 2010, at 11:06 AM, plange01 wrote:

    transocean (rig) is one of the best buys in the entire market....

  • Report this Comment On July 29, 2010, at 11:15 AM, TMFGreenwave wrote:

    Hi everyone, I'm the author of today's 11 O'clock Stock pick. I'd be happy to answer any questions (please be gentle) that you might have.

    Thanks for reading,

    Dave

  • Report this Comment On July 29, 2010, at 12:23 PM, Fool wrote:

    Hi Dave,

    Thanks for the great article. I definitely agree with you that the drilling industry as a whole has suffered some severe collateral damage from the BP spill.

    I have a question for you regarding the comparison between Noble and Diamond Offshore. At 2.4X BV, with revenues similar to NE, I can see why it's hard to call DO the value play here.

    But, one thing not mentioned in your article is the dividend factor. DO has rewarded shareholders through issuing special dividends. They have paid a special dividend of $1.87 a quarter for quite some time (though this was recently reduced).

    Do you know if Noble management also utilizes special dividends? Or, if not, is there an alternative way that they prefer to create value for shareholders that DO does not prescribe to?

  • Report this Comment On July 29, 2010, at 12:52 PM, TMFGreenwave wrote:

    Hi TXinvestor82,

    Thanks for the kind words. If you are looking for an income play in the sector Diamond's special dividend is attractive, but keep in mind DO cut it by 45% last week to "maintain the company's financial strength and strategic flexibility, as well as to position us for potential rig-acquisition opportunities."

    Which is exactly what Noble has already done with the Frontier purchase. Market conditions have created a chance for healthy drillers expand by picking up rigs from more distressed operators. Right now, I think smart purchases will create more value than simply returning excess cash to shareholders.

    Dave

  • Report this Comment On July 29, 2010, at 1:24 PM, TDRH wrote:

    Dave,

    Nice presentation, but you may want to double check the number one client of Noble. You can see the fleet locations and day rates on their website. Also, what impact do you see on day rates from the entrance of the new Next Generation Deepwater Rigs from these players and others, combined with the Gulf Moratorium?

  • Report this Comment On July 29, 2010, at 2:44 PM, TMFGreenwave wrote:

    Hi TDRH,

    Petrobras is Noble's biggest client right now. Pemex has more rigs, but the value of the contracts with PBR is greater. Going forward I expect Shell to take the #1 spot because of the Frontier deal.

    There is no question that the moratorium has pushed rates downward. In Noble's case, a few contracts with Shell were revised since the rigs are temporarily idle. Further, units leaving the Gulf are also putting pressure on rates internationally. But lets keep in mind this is a temporary situation.

    As for the newbuilds that is definitely a situation to monitor over the next couple years. However, good chunk of the new rigs will be ultra deepwater (75oo+ ft) capable and won't be competing with the current deepwater units.

  • Report this Comment On July 29, 2010, at 2:46 PM, TMFGreenwave wrote:

    Fool analyst Toby Shute wrote a great article on the coming wave of newbuilds here:

    http://www.fool.com/investing/general/2010/02/16/deepwater-d...

    Cheers,

    Dave

  • Report this Comment On July 30, 2010, at 6:14 AM, Wesss wrote:

    Good stuff, Dave.

    Sorry, but I read this sentence several times and still can't understand it...Could you please clarify?

    "Anadarko Petroleum (NYSE: APC) has declared force majeure on Noble, and it is likely that the company will feel the moratorium's financial impact for a couple of quarters."

  • Report this Comment On August 02, 2010, at 1:59 AM, gloomisglx wrote:

    Wesss

    Anadarko claimed force majeure to cancel a $440,000 per day contract with one of Nobles rigs in the gulf. Noble is protesting this and it may end up in court. For now that revenue is gone. Also the rigs Noble had with Shell are on a reduced standby rate until the moratorium is over, then they will pick up at the original contract rate. This means revenue will be reduced until moratorium over.

  • Report this Comment On August 13, 2010, at 4:53 PM, 5092 wrote:

    Noble drilling made the mistake to buy Frontier for over USD2b. The fleet it purchased consist out of the driller an old rig on steroids, the drillship Phoenix, an another old rig, the discovery is a rig more then 40 years old. frontier tried to move the rig last year to Australia but they could not get a safety case because the ship is not up to today's standards. Now this is the ship that Shell wants to use in the Arctic, go figure after the recent GOM incident. the only good thing in the acquisition are the two each Bully rigs however they will be using an unproven Derrick design. Both rigs were scheduled to be delivered by the shipyard last year, revised delivery was now Q4 2010 but noble wisely has reset the delivery to Q2 2011. Watch the next 12 months, I predict that Noble has underestimated the cost and timing to get both rigs working acceptably. They are experiencing a similar issue with the upgrades of their drillships in Brazil. Keep an eye on the investment for the next couple of years. The engineering of noble is not very strong. Good luck my dear friend Fools.

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