Shares of offshore drilling companies have been getting punished severely by the markets recently due to fears of an industry shutdown. While it is true that the offshore drilling industry is slowing down from its previously red hot levels, not all drilling contractors will be equally affected. In fact, some will not be affected much at all and many of these have been sold off by investors alongside their much more heavily exposed peers. One such company is Norwegian harsh environment drilling specialist North Atlantic Drilling (NYSE:NADL). The fact that this company, along with others like it, has been sold off by the market offers opportunities for investors that are looking for a very high-yielding, undervalued stock.
About North Atlantic drilling
North Atlantic Drilling, a majority-owned subsidiary of Seadrill (NYSE:SDRL), owns and manages the largest fleet of harsh environment-capable offshore drilling rigs in the world. This fleet consists of five semisubmersibles, three jackups, and one drillship. All of these rigs are harsh environment-capable and many are also capable of operating in ultra-deepwater environments. This also gives the company one of the most technically capable fleets of harsh-environment rigs in the world and this provides the company with a competitive advantage.
Long-term contracts provide protection
One of the reasons why North Atlantic Drilling will not be significantly affected by a short- to medium-term downturn in the offshore drilling market is that contracts for harsh-environment rigs are typically for long periods of time. This chart shows the current contracts that each of North Atlantic Drilling's rigs has. As the chart shows, they all have contracts that last for several years.
One thing that investors should note in the table above is that North Atlantic Drilling has no expiring contracts in 2014. This means that the company is contractually guaranteed to receive all of its cash flow for this entire year regardless of what happens in the market for offshore drilling rigs.
However, what if the current downturn lasts beyond 2014? Well, North Atlantic Drilling has a significant amount of protection going forward as well. The company has very little exposure to the market in 2015, with only its drillship being available for the whole year. The company does have two of its semisubmersibles, the West Venture and West Phoenix, coming off contract halfway through 2015, but otherwise it is still contractually guaranteed to keep generating revenues and cash flow straight through to 2016. Thus, North Atlantic Drilling is largely protected unless the market downturn lasts until 2016.
Risks if the downturn lasts longer than expected
There are still certainly some risks here that every investor and potential investor should be aware of. For starters, the company does still have availability on three of its rigs in 2015. Should the company fail to secure new contracts for these rigs at either the same or similar dayrates then it could see its revenue and cash flow drop as these rigs come off contract. This could be enough to jeopardize the company's dividend should the drop in cash flow be large enough.
The market is handing us a cheap stock with a high yield
However, the market's sell-off of North Atlantic Drilling's stock has managed to push the stock price so low that it is now cheap even when the relatively minimal risks are considered. At the time of writing, North Atlantic Drilling trades for $8.38 per share. At this level, the stock has a P/E of 8.10, an EV/EBITDA of 7.86, and a price-to-book ratio of 2.22. However, one of the biggest indicators that the stock may be extraordinarily cheap is that its dividend yield is now into the double-digits.
In a recent article, I stated that the company increased its dividend to $0.92 per year following its fourth quarter earnings announcement. At this level, the stock yields 10.98%. This makes it one of the highest yielding stocks on the NYSE. This dividend also suggests that investors in the company will receive a return that is at least in line with, if not beating, the market's historical average. This is true even if the stock price doesn't move from today's levels. Thus, a good deal of the company's risks are already priced into the stock, and the market appears to be overestimating these risks.
North Atlantic Drilling is not the only drilling company that is well-positioned to ride through the current weakness in the market without any ill effects, nor is it the only one that pays a high dividend. But a high dividend is quite desirable in the current weak market because until the drilling market begins to firm up again, capital gains are likely to be minimal from any of the drilling companies.
Therefore, dividends will likely be the only return that investors are likely to get. One company that is likely to ride through the downturn without any ill effect is North Atlantic Drilling's sister company, Seadrill Partners (NYSE:SDLP), whose long contracts promise to protect it from any short-term market weakness. The best play on offshore drilling?
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The best play on offshore drilling?
Daniel Gibbs has a lon position in Seadrill and North Atlantic Drilling. His research firm, Powerhedge LLC, has a business relationship with a registered investment advisor whose clients may hold positions in any of the stocks mentioned. Powerhedge LLC has no position in any stocks mentioned and is not a registered investment advisor. 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.