Here's Why Start-Up Issues Aren't a Concern for Ocean Rig

Start-up issues continue to impact a lot of the new deepwater drillships, but the long-term execution of Ocean Rig and other players like Atwood Oceanics and Pacific Drilling make for intriguing valuations.

Jul 17, 2014 at 4:25PM

For a relatively young company forecasting fast growth, offshore drilling contractor Ocean Rig (NASDAQ:ORIG) trades at a very attractive earnings multiple. The company continues to bump along with start-up issues from new drillships, but it appears poised to produce strong results going forward based on a solid contract book and an improving deepwater drilling market.

Highlights from the previous quarter
For the first quarter of 2014, the company produced adjusted EBITDA that grew nearly 70% to reach $172.2 million, leading to a slight earnings miss of only $0.25. The company missed expectations due to downtime at the new Ocean Rig Mylos that had issues with the BOP. Due to this and other start-up problems, the operating efficiency for the quarter fell to only 85.9%. Outside of the new rig, the company produced a solid 94% efficiency level. Even better, the five oldest rigs all had operating efficiency rates in excess of 94%, suggesting operations are solid once past the start-up period.

The offshore driller isn't alone in running into issues with new rigs. Both Pacific Drilling (NYSE:PACD) and Atwood Oceanics (NYSE:ATW) recently ran into similar issues breaking in new rigs. Pacific Drilling did even worse in the last quarter with an efficiency level of only 82.7%, due mainly to a start-up issue on the Pacific Khamsin only spread among a fleet of five rigs. The company produced a level of 95.6% in the prior quarter, suggesting the normalized levels are strong.

While the prior two firms are relatively young deepwater drillers in the process of building up contract books, Atwood Oceanics is a well-established offshore driller that aggressively built up new assets. The company recently ran into start-up challenges of the Atwood Advantage as well, which resulted in 22 zero-rate days in March and roughly an equal amount impacting the second quarter.

Forward growth prospects
Despite the weakness in the offshore drilling market, Ocean Rig continues to grow with new drillships finishing construction and starting new long-term contracts. In March, the company took delivery of the Ocean Rig Athena, which is now working in Angola for a six-year contract worth $1.3 billion. In addition, the Ocean Rig Skyros began drilling operations in Angola in early March and recently finalized a contract for a six-year contract worth an estimated $1.3 billion.

The prospects are even better considering the fleet was booked for over 70% of the calendar days in 2015 prior to the Eirik Raude deal adding another 260 days booked for 2015. Based on these new drillships starting operations, analysts forecast revenue surging over 60% for the quarter and nearly 45% for the full-year. More importantly, earnings that have bounced around flat for the last three quarters will surge to $0.39 for the second quarter and $0.62 for the third quarter.

Bottom line
With Ocean Rig producing fast growth from the start-up of new rigs and trading at only 8x forward earnings, the stock is relatively cheap in the current market. A start-up issue aside, the company is producing strong operations for a relatively young company in the offshore industry. Investors should watch out for a bumpy ride over the next quarter or so with new rigs, but the outstanding performance of existing rigs and long-term contracts provides significant insight into an attractively valued stock. Even more interestingly, the company now pays investors a 3.8% dividend to wait for improving operations and the market to realize the deepwater driller stocks should trade at higher multiples based on the long-term growth prospects.

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Mark Holder and Stone Fox Capital clients own shares of Atwood Oceanics. The Motley Fool recommends Atwood Oceanics. The Motley Fool owns shares of Atwood Oceanics. 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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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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