These Offshore Drillers Could Be Set for Further Pain

The offshore drilling sector has not had a good year. Year to date, Transocean's (NYSE: RIG  ) shares have fallen 16%, Diamond Offshore (NYSE: DO  ) has fallen 11%, and Seadrill (NYSE: SDRL  ) is down 13%. These declines are a result of speculation that the offshore drilling industry is about to enter a two-year slowdown.

Unfortunately, yet more speculation has recently emerged. This time, though, it is in the form of a warning to value investors. The speculation states that these investors could be falling into a value trap by taking a position in one of the heavily sold-off drillers.

Looking cheap
At current levels, the offshore drillers look cheap. Diamond Offshore, for example, currently trades at a 2015 P/E of 9.8 and price-to-book ratio of 1.5. Transocean trades at a forward earnings multiple of 8.1 and a price-to-book of 0.9. Seadrill trades at a forward P/E of 7.9 and a price-to-book of 2.2.

While these valuations appear attractive at first glance, analysts at Barclays see numerous headwinds going forward. This could result in earnings forecasts heading for another round of downgrades, leaving the above drillers looking expensive instead of cheap at current levels. 

Barclays believes that there is a 30% downside to current earnings-per-share forecasts for the next few years after factoring in items such as lower-than-expected day rates and lower fleet utilization rates. With this being the case, analysts believe that after taking into account the worst-case scenario (in this case, a 30% slump in earnings), Diamond could be trading at forward P/E for 2015 of 26.2 times, Transocean at a ratio of 12.9 times, and Seadrill at a ratio of 9.1 times. These forecasts are not so harsh on Seadrill, but they make Diamond look expensive right now. Transocean, on the other hand, appears appropriately priced. 

This is not the first time that Barclays has issued such a dismal forecast on the industry's outlook. Back in January, the bank issued a research note stating that drillship day rates could fall as much as 16% over the next few quarters. As a result, the company downgraded 2015 earnings forecasts by as much as 40% for some companies.

The bank also reiterated the fact that companies with high leverage were going to suffer the most. These forecasts took aim at Seadrill specifically, and claimed that the company's shares could collapse a further 52% if the forecasts proved accurate.

Only time will tell if Barclays' forecasts will come true. As of yet there have been no such declines.

Net asset values could fall
Unfortuanly, Wall Street analysts have another warning for value investors. Analysts believe that as day rates deteriorate, net asset values of offshore assets are going to decline.

Net asset values are usually used by value investors to establish a base case for investment. If a company's stock is trading below its net asset value per share, it is considered undervalued. Wall Street believes that underlying net asset values of drillers could decline from their present levels, similar to the way that net asset values were written down by 16% following the financial crisis and then 8% after the Macondo disaster.

With this in mind, it could be the case that the price-to-book values of Transocean, Diamond, and Seadrill are all pushed higher as the value of assets decline and debt remains constant. 

Foolish summary
There continues to be much speculation about the state of the offshore drilling industry. These forecasts from Barclays add yet more confusion to the industry's outlook. Still, these views are interesting to note. They also seem to correspond with many other analysts who are calling for a drop in offshore drilling profits over the next few years. Investors need to be cautious.

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Read/Post Comments (5) | Recommend This Article (3)

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 28, 2014, at 12:18 PM, postnasaldrip wrote:

    Your inclusion of SDRL into this group shows you are not aware of this week's news items. SDRL/NADL has signed a huge deal with Rosneft which will all but guarantee employment of all rigs, both now in service or newbuilds for many years into the future, and at great utilization rates.

  • Report this Comment On May 28, 2014, at 12:57 PM, fdranger wrote:

    Too many emotional conclusions drawn from one cited report (Barclay). Need to read "the rest of the story" before jumping on the Barclay Band Wagon!

  • Report this Comment On May 28, 2014, at 8:25 PM, awallejr wrote:

    He has been bashing SDRL for about 5 articles now. I wonder if he is reading the reports of the Barclay guys who said SDRL is going to 18.

  • Report this Comment On May 28, 2014, at 8:44 PM, Heidikitty wrote:

    After a report I read on SDRL and North Atlantic drilling I am Long SDRL Would like more info on that deal.

  • Report this Comment On June 01, 2014, at 7:38 PM, MarioCarbone wrote:

    This nosense about value trap is based on idea of one individual analyst that didn't explain why he believed that prices in this industry will HAVE TO go down 30%.

    With such aproach every industry is value trap. Can you imagine if you predict that tomorow banking commisions go on half. We should close all the banks because will go to bankrupcy. And clever analysts would lose job. Finally :)

    If we speak seriously tha prices for offshore drillers would go down if industry won't be competitive against onshore drillers. But is is competitive because prices that form the cost to get oil offshore in deep sea are still at least 10% lower of the average onshore drilling. So the primary projects will be still on sea and with competitive market as it is, the prices are already around optimal level.

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