Why Pacific Drilling SA Could See Tremendous Growth in 2014

Offshore drilling contractor Pacific Drilling reported results that left some investors unimpressed. However, the company looks poised to overcome this and show tremendous growth in 2014.

May 13, 2014 at 12:43PM

Offshore drilling contractor Pacific Drilling (NYSE:PACD) announced its first quarter 2014 results last week. These results showed strong growth from the first quarter of last year, which was largely expected due to the company having an additional rig that was operating in this quarter but was not operating in the first quarter of last year. Despite the growth, however, the company's CEO apparently did not feel that the company lived up to its full potential in the quarter, and we very well may see further growth for the company going forward.

Highlights from the report
In the first quarter of 2014, Pacific Drilling reported total revenue of $225.6 million. This represents a 29% increase over the first quarter of last year and a 12.5% increase over the fourth quarter. Pacific Drilling also reported very impressive EBITDA growth. The company's EBITDA passed $100 million for the first time ever, coming in at $100.9 million in the quarter. This represents a 27% increase over the first quarter of last year and a 4.77% increase over the fourth quarter of last year. All-in-all, this was very impressive growth from the fast-growing driller.

Reasons for the CEO's disappointment
As I mentioned, Pacific Drilling's CEO expressed some disappointment about his company's performance during the first quarter:

We delivered our fifth consecutive quarter of increasing revenue. Cash flow from operations reached a new high, and EBITDA exceeded $100 million for the first time. However, we have room to improve. During the first quarter, the challenges of starting operations with the Pacific Khamsin were greater than we anticipated and resulted in a reduction to revenue and EBITDA.

One of the reasons for the Pacific Khamsin's troubled start is that the rig was going through what is known as its "break-in period." This corresponds to about the first six months or so after a rig commences operations during which time the rig is less reliable than it will be later on in its life.

This is largely due to the machinery first settling in and beginning to operate. Additionally, any defects in the equipment that need to be repaired will manifest themselves during this time. Sometimes the drill head will also encounter conditions on the seafloor that it was not designed for, so the machine will fail and require replacement.

After these first six months or so have passed then any problems will have already manifested themselves and been repaired and the rig will enjoy much more reliable operation going forward.

As the Pacific Khamsin's operations become more reliable, the company should see further growth. This is partly due to the dayrate on this rig. The Pacific Khamsin has the highest dayrate in Pacific Drilling's fleet, a remarkable $660,000 per day. In the first quarter though, the rig was not able to really take advantage of this dayrate due to the mechanical problems that the rig was having.

While the Pacific Khamsin's presence did boost Pacific Drilling's revenue, the boost was not as large as it would have been in the absence of these problems. This is because customers do not pay dayrate for days that the rig is out of service due to maintenance or repairs. Therefore, as the rig's performance improves going forward, it should produce more revenue for Pacific Drilling because it will be spending more time in operation.

Potential Challenges in 2014
Pacific Drilling reiterated that 2014 is likely to be challenging for the industry. This is a sentiment which has also been echoed by the management teams at other offshore drilling contractors such as Seadrill and Ocean Rig (NASDAQ:ORIG). However, Pacific Drilling itself will not be significantly adversely affected at this point as it only has one rig under construction that has not yet secured a contract.

This rig is the Pacific Meltem, and Pacific Drilling talked extensively about its efforts to secure a contract for this rig during its first quarter conference call. The rig will not leave the shipyard until the third quarter so the company still has time to secure a contract, but it would be reassuring to see one signed before then.

Fortunately, the rig has relatively limited competition for the oil field exploration and development projects that exist. This is because there are only three or four sixth-generation rigs (like the Pacific Meltem) in the world today that do not already have contracts.  While there are some fifth-generation rigs available that may be able to provide competition for contracts on some projects, this will certainly not be the case on all development contracts.

Therefore, Pacific Drilling should be able to secure a contract for this rig and that combined with another of the company's rigs that starts work in May should produce strong growth for the company over the course of 2014.

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Daniel Gibbs has long positions in Pacific Drilling and Seadrill. His research firm, Powerhedge LLC, has a business relationship with a registered investment advisor whose clients may own positions in any 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.

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