This Tiny Offshore Driller Is Likely to Outperform Larger Sector Peers

Vantage Drilling is a fraction of the size of industry leader Seadrill but Vantages new fleet is in demand.

Mar 14, 2014 at 10:30AM

In the world of offshore drilling, Vantage (NYSEMKT:VTG) is a relatively small company. Indeed, with a market capitalization of only $533 million, the company pales in comparison to industry leading peers, Seadrill (NYSE:SDRL) and Transocean, which have market caps of around $16 billion.

Nevertheless, Vantage is well placed for current industry trends, and despite its small size, Vantage could be a sector leader in terms of performance during the next few years.

To understand why Vantage is set to succeed over the next few years we need to take a look at current industry trends.

Current trends
It is widely believed that the offshore drilling industry is going to have a hard time over the next few years. Several Wall Street analysts covering the sector have stated that the day rates for ultra-deepwater drilling, or UDW, units will slide by 16% over the next few years. As a result, earnings forecasts for the industry between now and 2015 have been slashed by a fifth. Industry leader Seadrill's management explains:

"[As] producers work through the forward budgeting process the entire spending complex tends to slow down. Oil companies suffer from limited free cash flow and claim that capex[capital spending] is inflated because of higher rates for offshore services. They are trying to ease this situation by reining in spending levels."

And commenting on their own outlook:

"[We] see no significant reduction of our cash flow if the market is hit by a temporary setback. Medium to long term the current reduction in capex by the oil companies is expected to lead to less production, a tighter oil market and a rig market with fewer newbuilds...better fundamentals for drilling companies with modern assets and solid financing structures.[Seadrill will benefit]."

So all in all, this implies that drillers with younger fleets will do better than their aged peers. Actually, Seadrill estimates that by 2020 the majority of the global jack-up drilling unit fleet will be over 35 years old. Additionally, due to safety concerns, many oil exploration companies are exclusively using sixth generation drilling units with the most high-tech equipment so drilling companies with older fleets are likely to find it hard going during the next few years.

Vantage is set to benefit
Now, Vantage has one of the youngest jack-up fleets in the drilling business, which puts the company in a great position to ride out the trends emerging within the offshore drilling industry. In particular, the average age of Vantage's jack-up fleet is under five years, approximately one year younger than Seadrill's fleet.

What's more, Vantage is one of only four drillers, with 100% of the jack up fleet able to drill deeper than 350 feet -- deepwater in other words. But that's not all: Vantage's UDW drillship fleet has an average age of a year, although this fleet is only comprised of four units, one of which is yet to be delivered. Still, this young fleet means Vantage's services are likely to be in demand over the next few years as customers fight over the company's high-tech modern fleet with 100% UDW capabilities.

A well placed peer
The other company with one of the youngest drillship fleets in the business is Rowan Companies (NYSE:RDC). Rowan is taking delivery of four UDW drill ships this year, the company's only drillship units, which gives Rowan the youngest drillship fleet in the business with an average age of a month or so as only one of the four units has so far been completed. Three of these units are already contracted out.

The first drillship to be delivered is currently in transit to West Africa to begin testing before commencing a three-year contract with Repsol in April; this should boost Rowan's bottom line from the second quarter. The three remaining drillships will be delivered throughout the year. You can read more about Rowan's future here.

There is a problem
Unfortunately, while Vantage is well placed to ride out current industry trends, the company's debt is an issue.

Vantage's debt-to-EBITDA ratio was 7.8 during 2013. To quickly put that into some perspective, Seadrill, which is considered by some to have a high level of debt, had a debt-to-EBITDA ratio of 5.4x during 2013, and the company's gearing ratio was 180%; Vantage's gearing ratio was closer to 450% during 2013.

That being said, Vantage's management believes that as the company's newly commissioned drillships come online during the next year, debt-to-EBITDA will drop to 5 and the resulting cash flows will cover all debt maturing before 2019. So, despite the company's high level of debt, it would appear that it has everything under control.

Foolish summary
So overall, despite Vantage's small size and relatively high level of debt, the company is well placed to ride industry trends currently developing. With Vantage's fleet of modern drilling units the company is likely to report a strong demand for its services over the next few years, putting the company in a great position to pay down debt, reward investors, and grow the fleet further.

Another way to profit from drilling
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Rupert Hargreaves owns shares of Rowan Companies. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill. 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 insights makes us better investors. The Motley Fool has a disclosure policy.

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