Yet Another Plunge Forecast for Deepwater Drillers

It seems that just about every analyst can't wait to forecast a potential plunge in deepwater and offshore drillers. The latest is an analyst call out of Barclays that the general offshore sector, including the deepwater drillers, will take a hit.

Only a few weeks back, the focus was on the difference between the legacy drillers and the modern drillers. The latest report from Barclays brought a few more firms into focus, including Atwood Oceanics (NYSE: ATW  ) , Rowan (NYSE: RDC  ) , and a big hit to Diamond Offshore Drilling (NYSE: DO  ) .

Analysts James West and Zachary Sadow suggest further downside exists for those stocks before they find support at net asset value, or NAV. The analysts suggest that the stocks could fall down to NAV and, combined with a drop in NAV from a weak market, the average stock has 40% downside. The analysts, however, compared this level to the NAV declines during the financial crisis and the Macondo well explosion, hardly comparable events.

For investors, the better key to the report might be the updated price targets. Atwood Oceanics was cut to $70 from $75, Diamond Offshore Drilling to $52 from $64, and Rowan to $44 from $48. Investors should take note that these analysts aren't confident of the major declines based on these targets, especially in the case of Atwood Oceanics currently trading at only 6x forward earnings estimates.

Hybrid fleet
While Atwood Oceanics would technically classify as a legacy driller, the company undertook an aggressive newbuild program several years back. Starting with a small legacy fleet, it has completely transformed the fleet to mostly modern rigs in both the deepwater and jackup segments.

Atwood Oceanics has spent the last six years building nine new rigs to modernize the fleet. The company has a total of 13 rigs and is constructing three ultra-deepwater drillships. In fact, according to the slide provided by the company in the recent presentation, it has progressed from an old legacy fleet to one of the youngest in the industry.

Source: Atwood investor presentation

With the stock currently trading around $47, the Barclays target should actually make the stock a compelling buy.

Interesting value
Based on the updated price target, Rowan offers intriguing value. The drilling company is more focused on the jackup rig segment over deepwater drilling, but the stock is attractive considering the bearish analysts suggest it is worth $44 while trading at just $30 now.

Currently, Rowan has only one ultra-deepwater rig working with three under construction. The company is very focused on a fleet of 30 jack-up rigs that work in the shallow water areas.

Back when the company reported fourth-quarter numbers, the company had 17 jack-up rigs coming off contract during the year. On the deepwater drillships, the company initiated its first ship earlier this year and has two more completing construction this year with three-year contracts. Similar to most other firms, the company has a new deepwater drillship taking delivery in early 2015 without a contract at this point.

Despite the negative Barclays view, the average analyst expects earnings to continue rising, and the stock trades below 7x earnings.

No value
With Diamond Offshore trading around $48, the stock doesn't offer much value with a price target of only $52. The analysts were a lot more negative on this driller with a nearly 20% cut to the price target. One has to wonder what took so long to cut the target considering the stock sat at $70 last year.

Diamond Offshore was already identified as a legacy driller with old rigs facing cold stacking or dismantling. The market wants the new rigs built by Atwood Oceanics and even the ones Diamond Offshore is building. Worth noting, analysts have slashed earnings estimates for 2014 to nearly 20% below the $4.78 earned in 2013.

Bottom line
The offshore industry, especially the deepwater drilling segment, is under pressure from negative analyst calls, yet the group remains attractive from a valuation standpoint in a market with high-flying stocks crashing. When reviewing this sector, it's difficult for investors to generalize the market as overvalued anymore. Pockets of value exist, and these deepwater drillers provide intriguing prices. One simple conclusion is to follow the price targets of Barclays and invest in Atwood Oceanics first and Rowan next.


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