Ocean Rig: Premium Rigs For a Premium Market

Ocean Rig appears perfectly aligned for a market demanding premium rigs, while Noble Corp has a lot of work to do in order to contract outdated equipment.

Feb 24, 2014 at 3:53PM

In the face of what is supposed to be a difficult offshore deepwater drilling market, Ocean Rig (NASDAQ:ORIG) produced a very impressive quarter. The CEO downplayed any weak market conditions in the premium rig area, suggesting that upcoming contract announcements would provide a clear price point for premium units.

The results bode well for a deepwater driller loaded with new, premium rigs that has seen its stock stagnate since originally going public and trading around this same $17 level. The news is promising for Pacific Drilling (NYSE:PACD) that has an even more premium fleet, yet has a few rigs lacking contracts for 2014. It also questions some of the concerns originally brought up by Noble Corp (NYSE:NE).

The combined input of numerous firms suggests that the premium deepwater rigs should skate through this period without much of an impact. In that case, Ocean Rig and Pacific Drilling offer a lot of promise while Noble may face a scenario where an old fleet either prices contracts at lower rates or rigs might need to be removed from service.

Strong results

For the fourth quarter, Ocean Rig smashed estimates by earning $0.30 per share on revenue of $345.5 million. The earnings far outpaced the $0.16 expected by analysts. The company has significantly surpassed estimates each quarter in the past year, so maybe these numbers shouldn't surprise investors.

Ocean Rig generated adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of $163.8 million during the fourth quarter setting it up for huge EBITDA numbers during 2014 and 2015 with the additional rigs working. Pacific Drilling won't report fourth-quarter numbers until Feb. 25, but the deepwater driller only generated EBITDA of $96.6 million, though the EBITDA margin was a solid 50%. Even Ocean Rig only generated an EBITDA margin of 47.5%.

Noble plunged after suggesting that the offshore drilling market was facing a short-term pause that might refresh the market. The indication from other deepwater competitors is that a bifurcation is taking place in the market where premium rigs find good contracts and outdated equipment struggles to find acceptable work. Unfortunately, Noble Corp sits in the later group with a set of rigs it hopes to spin-off into a separate company in order to focus on the premium market.

Visibility via a backlog
Compared to some of the backlog concerns of Pacific Drilling, Ocean Rig has the fleet fully contracted for 2014 and 72% contracted for 2015. The company does have a rig coming off contract on a quarterly basis starting in the first quarter of 2015, but it isn't anything concerning at this point. The good news is that the two new ultra-deepwater rigs with expected deliveries in the next year have already signed three-year contracts. If the sector does take a pause during 2014, then Ocean Rig appears best suited to thrive.

Pacific Drilling faces more immediate issues with a new drillship delivery during the third quarter without an announced contract, as of yet. Also, the company has up to three rigs facing contract renewals around the end of 2014 that could cause problems if the market were to run into a cyclical downturn or even a pause that lasts a full year.

As of Dec. 31, Noble sits on a backlog of $15.4 billion, though only approximately 73% of the company's available rig days were committed. The number gets a lot worse in 2015 with only 44% of the available rig days under contract.

Bottom line
Investors should watch for signs of a change in the bifurcation of the current deepwater drilling market. For now, Ocean Rig appears set up to take advantage of a premium fleet that can command premium prices. It appears the stock has traded in the current range based on unfounded fears.

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