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In the middle of rehashing the same short-term weakness story in the deepwater drilling sector, Atwood Oceanics (NYSE: ATW ) actually admitted that the weakness in the market was only impacting the old rigs. The company, while being cautious the whole earnings conference call, actually admitted that the bifurcation in the market is an opportunity and not a threat.
The call started with the general theme of the Noble Corp. (NYSE: NE ) report calling for a pause that would refresh the market. Atwood Oceanics discussed slowing demand, which would hamper old rigs that might be cold stacked eventually. Atwood Oceanics hasn't actually seen any slack in demand for the high-specification rigs it is building. The report generally backs the ongoing theme of SeaDrill (NYSE: SDRL ) that new deepwater rigs will continue to command strong prices through at least 2020.
Atwood Oceanics has spent the last several years with an aggressive newbuild program that now might pay off in a meaningful way. The company recently took delivery of the Atwood Advantage, which is mobilizing to the Gulf of Mexico. The company has three more ultra-deepwater rigs under construction, including the Atwood Achiever, which is scheduled for delivery in June and under contract for three years at a day rate of nearly $600,000.
High contract levels
Considering the long-term nature of most deepwater drilling contracts, a short-term pause in contracts can have a dramatically different impact on drillers based on when existing contracts roll off. In the case of Noble, it has a whole segment of old, low-spec rigs that it plans to spin off into a separate company. Atwood and SeaDrill have fewer rigs that fall into that category, making them more constructive on any short-term impacts.
In the case of Atwood, it has three modern, ultra-deepwater rigs on contract through at least the end of 2016. Another rig will start in Sept. under a three-year deal. The first new rig under construction without a contract is not scheduled for delivery until early 2015. Based on the current market preference for new rigs, the expectation would be that it has no problem obtaining a solid day rate even if market weakness persists.
In that manner, Atwood proclaimed that 96% of 2014 operating days are under contract and around 70% of 2015 operating days are under contract. On the flip side, the major concern is that an older deepwater rig in the Atwood Hunter struggles to obtain a contract anywhere close to the $515,000 rate when it ends the current work in August.
While Atwood Oceanics ran into a couple of rig-specific issues that reduced revenue efficiency and profits during the last quarter, the deepwater driller still generated earnings of $1.28. Not many industries can produce those levels of profits during a weak quarter. Despite the lack of rigs coming off contract in the next nine months and beating estimates by $0.10 in the first quarter of fiscal 2014, analysts have dropped earnings down to $5.84 for this year and $7.81 for fiscal year 2015. Though the 2015 numbers are at higher risk due to the new rigs not under contract yet, the stock now trades at a forward P/E of only 6.
Surprisingly, Noble trades at a slightly higher forward P/E, while SeaDrill commands a relatively high valuation for the sector of 10x forward earnings.
The bifurcation in the deepwater drilling sector has investors dumping all stocks in the group. In reality, some stocks in the group are better situated for this move toward premium pricing for new rigs, while cold-stacking old rigs. In a lot of cases, E&P operators aren't willing to use the old rigs even at lower day rates, making those rigs uncompetitive.
With a full contract book and premium rigs, Atwood Oceanics is set to command a premium industry valuation. As the market works through the pause in growth during 2014, it should become more apparent that operators like Atwood and SeaDrill are best situated to lead a sector recovery.
An interesting play on deepwater drilling
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