Few industries have been as hard hit as offshore oil drillers in the last year. What started as a cyclical weakness in day rates due to short-term rig oversupply has been turned into a full blown price collapse courtesy of the worst oil crash since the financial panic.
However, in the spirit of "being greedy when others are fearful" let's look at Transocean (RIG 2.24%) and its competitors: Seadrill (SDRL), Ensco (VAL), Noble (NEBLQ), and Diamond Offshore (DO) to show why now may be the best time for long-term investors to invest.
Oh so very, very undervalued
| Company | Price to earnings | Historical PE | Price to tangible book |
| Transocean | 3.5 | 28.1 | 0.47 |
| Seadrill | 3.9 | 10.5 | 0.55 |
| Ensco | 4.5 | 24.3 | 0.75 |
| Noble | 4.9 | 21.4 | 0.52 |
| Diamond Offshore | 10.5 | 16.8 | 1.19 |
| Industry Median | 7.2 | 0.75 | |
| S&P 500 | 19.42 |
Sources: Fastgraphs, Morningstar.com, Multpl.com, Gurufocus.com
Anyway you look at it the offshore drilling industry is trading at historic undervalued levels and all of the above companies with the exception of Diamond Offshore are only more so. In fact, compared to their own historical average P/E ratios these offshore drillers can now be bought for historical discounts of 38% to 88%. And why it may be true that P/E ratios are only one metric among many that investors need to consider the fact that these companies assets are now trading for as little as 47 cents on the dollar means that now may be the perfect "Buffett moment" to snap up quality assets for far less than they will be worth in the future.
However, before you run out and back up the truck because of Transocean's super low price to tangible book value be aware that the value of some of these companies assets can fluctuate, some more so than others.
For example, Transocean recently had to take a $2.8 billion writedown due to the decrease in value of some of its older rigs which it's retiring, due to market weakness.
However, the assets of companies with newer ultra deep-water fleets such as Ensco and Seadrill are less likely to decline in value (or at least as drastically) and may indeed represent exceptional long-term investments.
What about the dividends?
| Company | Yield | EBITDA payout Ratio | Operating Cashflow Payout Ratio |
| Transocean | 17.70% | 122% | 43% |
| Seadrill | 0% | na | na |
| Ensco | 10.70% | 44% | 31% |
| Noble | 9.90% | 16% | 19% |
| Diamond Offshore | 1.50% | 7% | 8% |
| Industry Average | 9.50% | ||
| S&P 500 | 1.92% |
Sources: Yahoo Finance, Morningstar.com, Multpl.com
One of the things investors most appreciate about offshore drillers is their high dividend yields. While the crash in oil prices and weaker offshore market poses a risk to some of these payouts--Seadrill recently suspended its dividend in the face of its massive debt and oncoming capital requirements--some of these payouts are safer than others. For example, as the above table shows, Transocean's current sky-high yield looks to be the most at risk. This is especially true given the steep contract cliff the company faces during the weakest offshore drilling market in years.
Source: Pacific Drilling investor presentation
As you can see in this slide, 42% of Transocean's drilling days are without contracts for 2015. In addition, with 12 new rigs under construction Transocean's dividend is also threatened by the company's need to pay $1.5 billion to $2 billion annually to pay for those rigs.
Meanwhile Ensco, with a much newer ultra deep-water rig fleet, (which can command higher day rates) a smaller contract cliff, and much smaller debt burden ($4 billion less to be exact) would be my choice for one of the most sustainable dividend among offshore drillers.
Ongoing risks to the industry
Don't get me wrong; investments in offshore drillers even at current rock bottom prices aren't a sure thing. The current oil price crash and down turn in the offshore drilling market could get worse. For example, Suhail Al-Mazrouei, the energy minister for the United Arab Emirates, recently told Bloomberg that even if oil were to slide an additional 33% to $40/barrel, OPEC would likely "wait for at least a quarter" before cutting production.
In fact, some believe that oil could drop that low. For example Andy Xie, a former economist for Morgan Stanley and the IMF has recently told CNBC that he believes oil might drop to as low as $43/barrel and stay around $60 for five years.
According to Reuters the breakeven cost of deep water oil drilling is $54/barrel to $60/barrel, and if Xie is correct and oil does continue its slide than demand for offshore rigs might completely evaporate and even state of the art new rigs may not be able to find work. In such an environment even already signed contracts may not mean much.
For example, so far in 2014 Norwegian oil giant Statoil (EQNR -0.04%) has cancelled contracts on five rigs, including one owned by Transocean and one by Diamond Offshore. The cost of breaching this last contract alone came to $350 million but Statoil calculated that even that cost was better than continuing to drill in the current market environment.
Bottom line: If you believe in offshore drilling now is the time to invest
It's said that the best time to invest for the long term is when there is blood in the streets and few companies are bloodier than offshore drillers such as Transocean and its peers. Trading at massive discounts to the market, their own historical averages, and the value of their assets, these companies represent a long-term opportunity to invest in the future of the oil market when Wall Street is at its most despairing. While Transocean's dividend, like Seadrill's, may soon be suspended, certain companies like Ensco--whose dividend is more likely to be sustainable--may offer exceptional income opportunities as well as excellent future profits.
