Offshore Drillers Could Have Further to Fall

Trying to understand the offshore drilling market is tough to say the least. However, Wall Street has been quiet on the matter for some time now. Actually, it seems as if much of the Street, and other analysts, are waiting for trends in the industry to play out.

Additionally, like many investors, analysts will want to see how drillers are coping with the much-touted rig market slowdown when they release second quarter results over the next few weeks. 

All quiet
The last three months have been a good time to be invested within the offshore drilling sector. Drillers such as Seadrill (NYSE: SDRL  ) , Transocean (NYSE: RIG  ) , and Rowan Companies (NYSE: RDC  ) have all staged a small rally over the period, racking up gains of 14%, 7% and 1% respectively over the period.

However, this period has seen a lack of information ahead of second quarter results. What's more, the low valuations of companies like Rowan, coupled with Seadrill's hefty 10.6% annualized dividend payout, have attracted investors.

Nevertheless, longtime drilling industry critic Raymond James recently warned investors not to get too comfortable within the sector.

Indeed, analysts at Raymond James believe that the market slowdown still has some way to go and drillers could see their earnings drop even further from current levels. Analysts believe that the rig market is over-supplied, and as a result this downturn will last for several years, until the supply/demand balance of rigs is corrected.

To put some numbers on it, analysts believe that over the next three years, the time they believe the slowdown will take to play out, the average day rate for floater rigs will fall around 25%. Additionally, around 60 floating rigs will need to be staked over the period, taken out of the market in other words, to reduce supply. These are likely to be the oldest units of each fleet.

According to Raymond James analysts, these declines both in fleet utilization and day rates achieved will, on average, lead to a 25% downward revision of 2016 earnings estimates for offshore drillers. I must state that this is an average figure.

How will this affect drillers? It's hard to factor in an average 25% decline on 2016 results. Nevertheless, it is possible to factor in a downward revision of say 20% on current earnings forecasts for 2015.

Crunching numbers
According to the average Wall Street analyst estimate, Seadrill is expected to report earnings per share of $2.93 this year, followed by earnings of $3.43 per share for 2015. Factoring in a 20% decline, Seadrill could be set to earn $2.74 for 2015, putting the company on a 2015 P/E of 13.9.

According to the average Wall Street analyst estimate for Transocean, the group is set to report earnings per share of $4.24 this year, followed by earnings of $3.59 per share for 2015. Factor in a 20% decline and Transocean would earn $2.87 for 2015, putting the company at a 2015 P/E of around 15.

And finally Rowan. Rowan is set for rapid growth over the next few years, thanks to the delivery of four new ultra-deepwater drillships, which will more than double the company's average day rate received from current levels. As a result, the average Wall Street earnings estimate for Rowan is $2.39 this year, followed by earnings of $4.32 per share for 2015. With a 20% decline, Rowan would earn $3.47 for 2015, yielding a 2015 P/E of approximately 8.9.

I should say that the above figures are only back-of-the-envelope calculations, although they do give a rough idea of where the industry is going.

The bottom line
The offshore drilling industry has had a quiet few months, but Raymond James believes that there is further pain ahead. Analysts are predicting a 25% decline in 2016 earnings based on current industry trends. Still, Transocean's and Seadrill's hefty dividend payouts are more than enough to compensate investors waiting for a turnaround.

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