Oil Riggers Offer Opportunity

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Shares of oil riggers -- the companies that actually do the offshore oil drilling for the big oil names --have been on a roller-coaster over the past 15 months. The Deepwater Horizon oil spill last summer sank stock prices, which then rebounded as investors realized they overreacted, and new regulations proved less costly than expected. Then oil prices took off, pulling the riggers' stock prices even higher.

A unique industry
Oil riggers occupy a singular sector. There are fewer than 10 major players, which might normally suggest an oligopolistic marketplace -- but not here. Despite the concentration within the industry, remember the customer it serves: Big Oil. Even the largest rigger, Transocean (NYSE: RIG  ) pales in comparison to giant industry customers such as ExxonMobil (NYSE: XOM  ) , ConocoPhillips (NYSE: COP  ) , and BP (NYSE: BP  ) .

As a result, the riggers are price-takers. Assuming a rigger meets safety and reliability expectations, these guys provide a commodity service. Exxon doesn't care who drills its oil (and you don't care at the pump), and it will switch riggers if it can get a better price. And among the riggers, size carries no benefit. Contracts are per-rig, and nothing about having 50 rigs allows a rigger to offer a cheaper per-rig price than a contractor with just five rigs.

In this context, I think it is reasonable to expect that the market will likely value riggers similarly. After all, these companies all do the same thing for the same customers at the same prices, and their size doesn't matter. But riggers' valuations nonetheless vary considerably:

Company

EV

EV/EBITDA

P/E

P/TBV

Div yield

Atwood Oceanics (NYSE: ATW  ) 3,423 9.7 12.8 2.1 0%
Noble (NYSE: NE  ) 13,490 13.1 21.3 1.3 1.7%
Diamond Offshore (NYSE: DO  ) 10,357 6.2 10.8 2.5 4.9%
Transocean 28,084 7.9 48.9 1.5 0%
Ensco (NYSE: ESV  ) 6,931 9.1 17.0 1.4 2.6%
Rowan (NYSE: RDC  ) 5,900 11.2 19.0 1.3 0%
Seadrill (NYSE: SDRL  ) 26,207 11.5 8.5 3.3 7.5%

Swiss operator Noble costs 13.1 times EBITDA right now. Diamond Offshore can be bought for less than half of that. Seadrill sports a P/E of just 8.5, while Transocean commands a multiple just shy of 50 times earnings -- nearly six times higher. You can buy either Noble or Rowan for just 30% more than the value of their assets, but you'd need to pay 230% more than asset value to buy Seadrill. Diamond Offshore boasts a fat 4.9% dividend yield; three of its peers don't pay any dividend at all.

Opportunities in hiding?
To me, this industry is prime hunting ground for a pairs trade. That strategy involves simultaneously buying one stock and shorting a similar stock. Pairs trades remove factors that affect both stocks -- in this case, primarily oil prices, which are outside the riggers' control yet dramatically affect their financial performance -- and instead bet on one rigger relative to another. With the market assigning such disparate valuation multiples to the riggers, we might have a choice opportunity to buy a relatively undervalued rigger and short a relatively overvalued rigger, betting that the two valuations will converge over time.

I'm digging in further for a closer look at each rigger's strategy, operations, and valuation to determine whether they truly warrant their divergent valuations. I suspect that they don't, so look for me to make a judgment on this situation in the coming weeks. The best way to keep up with my thoughts is to follow me on Twitter.

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Alex Pape does not own shares of any company mentioned. The Motley Fool owns shares of Diamond Offshore Drilling, Noble, Ensco, and Transocean. Motley Fool newsletter services have recommended buying shares of Atwood Oceanics. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insightsmakes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (9)

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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 26, 2011, at 12:09 PM, dgrud wrote:

    Please check your dividend yield on SDRL

  • Report this Comment On July 26, 2011, at 12:16 PM, dgrud wrote:

    I think the oil co. do care who drills for them(BP oil spill) and are going to use the drillers with the most modern and safe rigs.Safety records of the different drillers will count in the companies decisions.

  • Report this Comment On July 26, 2011, at 12:17 PM, TempoAllegro wrote:

    Thanks very much for this article. It is more food for thought.

    There was a recent article on Seeking Alpha (July 24th) that referenced Transocean and brought up two points: it's older equipment compared to others in the industry and its possible inclusion again into the S&P 500. It also gave a link to another 10-page article at a different web site that gave exact details of RIG's fleet worldwide.

    It seems to me that RIG has already been discounted on the bad news from the Gulf of Mexico disaster. Clearly they are a leader in a needed part of the industry, but whether the stock is currently undervalued is a matter of opinion.

    Lots of people are enamoured of Seadrill, myself included, with their new fleet and good leadership. However, this article adds to my caution that the stock may be overpriced now.

  • Report this Comment On July 26, 2011, at 8:08 PM, surfgeezer wrote:

    When you dig more, you will see differences. As drud says safety and newness counts. SDRL is also expanding in Asia and adopting more management of rigs with owner shift.

  • Report this Comment On July 28, 2011, at 9:54 AM, lctycoon wrote:

    Double check your dividend yield on SDRL. It's a lot higher than that. The company pays a $0.70 quarterly dividend and an additional $0.05 quarterly special dividend. That's a yield of more than 9%.

    Also, where is that P/E ratio coming from? SDRL had 2010 earnings of $2.73 per share. Y! Finance and others seem to think that it earned $4.12 or some such. Is that the TTM number? If so, that's a bit high because SDRL had excessively high earnings last quarter due to an asset sale.

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