Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



The 3 Best Offshore Oil Drillers for High-Yield Investors

Editor's note: A previous version of this article referenced Noble Energy (an onshore E&P company) rather than Noble Corp (the offshore driller). The Fool regrets the error.

According to a study by Morgan Stanley and Rystad Energy, by 2035 the world's oil demand will increase by 13%-26%, causing prices to increase to $125/barrel-$150/barrel. 

To meet the massive demand in the face of aging and depleting land-based oil fields, oil companies are having to increase their E&P (exploration and production) budgets enormously. In 2013, total global E&P spending was almost $650 billion. To put that into perspective, according to the CIA world factbook, in 2012 the entire global economy was $85 trillion. This means that $1 of every $130 in the world is spent on finding and producing oil. 

The location of new oil fields is the key to this article and the investment opportunities it presents. Between 2012 and 2030 conventional, land-based oil production is expected to grow at just  a 1% CAGR. In contrast, ultra-deepwater production will grow at a 19% CAGR. 

Recently a series of negative articles and opinions by Wall Street's leading analysts have maximized negativity about the offshore drilling industry: 

  • An article in Barron's argues that oil will fall 25% to $75/barrel over the next five years.
  • Barclays predicts up to 40% downside for offshore oil drillers due to a glut of new rigs causing plummeting day rates.
  • Morgan Stanley and Citigroup predict falling day rates over the next two years will cause a collapse in the stock prices of offshore drillers.
This article is meant to show why these negative views of the offshore oil drilling industry are short-sighted and why now is the time for income investors to load up on cheap shares of the best offshore drillers. 
Why the analysts are wrong
In order to satisfy the demand for ultra-deepwater oil production in 2020, the world will need 455 ultra-deepwater (UDW) oil rigs. This is 165 more than exist now or are scheduled to be built. 
Thus the concerns over falling day rates due to a short-term glut of new UDW rigs is misguided because by 2016-2017 global demand will have easily absorbed the new supply. This will keep day rates high for the most advanced rigs. My favorite offshore driller exemplifies this point.

Seadrill (NYSE: SDRL  ) has a fleet of 49 rigs (34 UDWs), with another 20 to be delivered by 2016 (11 UDWs). With the most modern UDW fleet in the world (average age 3.2 years), concerns over falling day rates shouldn't apply to Seadrill. Ten out of Seadrill's eleven latest UDW contracts have been for higher day rates, including its highest rate ever ($653,000/day) signed in the fourth quarter of 2013.

With an almost 12% yield that even Barclay's calls "rock solid" and the stock trading at just eight times cash flows (25% below historical average), Seadrill is massively undervalued. In addition, management has recently undertaken a balance sheet strengthening plan to secure the dividend (and grow it gradually during the short-term weakness) while paying down debt.

Combine this with the 20% CAGR EBITDA growth management is projecting through 2016 (due to the fleet growth) and you have the potential for a great investment over the next decade, combining an already sky-high yield with the potential for dividend growth and substantial capital gains. 

Ensco plc  (NYSE: ESV  ) is my second favorite offshore oil driller for two key reasons.

First, it has the second most modern UDW fleet in the world (average age 3.9 years) with six new rigs to be delivered by 2016 (three of them UDW). Unlike Seadrill, which finances its new rigs with cheap debt, Ensco likes to mostly fund new rigs with cash flow -- a major reason why it has the lowest leverage ratio in its industry (27%).

In addition to a fast growing, super-modern UDW fleet, Ensco has the second highest yield in the industry -- 6%. With a payout ratio of 49% and cash flows predicted to grow by 12% annually, this dividend is not just safe but likely to grow in the future.

Noble Corp (NYSE: NE  )  is my third favorite offshore driller for three reasons.

First, the yield of 5% is the third highest in the industry, yet represents only a 25% payout ratio. 

Second, cash flow growth after 2015 (due to completion of its new build program) will fund dividend growth. 

Finally, it's spinning off standard rigs into a separate company (Paragon Offshore), leaving Noble a pure premium rig play. This will minimize exposure to short-term day rate weakness and further secure the dividend.

In addition, the Paragon IPO (summer 2014) will likely see Noble sell 20% of Paragon, resulting in further liquidity to pay down debt, secure the dividend, and grow it in the future.

Foolish takeaway
The current concern over offshore oil rig day rates is greatly overblown. The current price weakness is a terrific opportunity for long-term income investors to cash in on one of the strongest megatrends of the next few decades and achieve the trifecta of investing: high yield, fast growing dividends, and superior capital gains.

Cash in on rising spending in the energy industry
Imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!


Read/Post Comments (2) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 15, 2014, at 10:50 PM, PebbledShore wrote:

    Except NE is Noble Corp., not Noble Energy, which is ticker NBL.

  • Report this Comment On May 17, 2014, at 10:19 AM, AdamGalas wrote:

    Thank you for catching my error. The last thing I want to do is confuse investors and send them down the wrong path.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2959574, ~/Articles/ArticleHandler.aspx, 8/28/2015 5:30:24 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Adam Galas

Adam Galas is an energy writer for The Motley Fool and a retired Army Medical Services Officer. After serving his country in the global war on terror, he has come home to serve investors by teaching them how to invest better in order to achieve their financial dreams.

Today's Market

updated 8 hours ago Sponsored by:
DOW 16,654.77 369.26 2.27%
S&P 500 1,987.66 47.15 2.43%
NASD 4,812.71 115.17 2.45%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/27/2015 4:01 PM
ESV $17.03 Up +1.58 +10.23%
Ensco CAPS Rating: ****
NE $12.39 Up +1.34 +12.13%
Noble Corp CAPS Rating: ****
SDRL $7.38 Up +0.88 +13.54%
Seadrill CAPS Rating: ****