Shares of Atwood Oceanics (ATW) rose sharply last month, ending up more than 33%. Three factors fueled that move: Higher oil prices, a new drilling contract, and a near industrywide analyst upgrade.
Crude prices took off last month, with the global oil benchmark, Brent, rising 8.8% and closing at $57.54 a barrel. That price point pushes crude closer to the level that would incentivize oil companies to increase their investments in offshore sources. That higher spending level would enable drilling contractors like Atwood to secure additional contracts for their rigs, potentially at higher rates.
The rise in crude already seems to be leading to some improvement in market conditions. One evidence of this is Atwood signing a four-month contract extension for one of its rigs last month. Further, the deal was for a higher dayrate than the current one, and it includes two four-month options priced at even higher rates. That's great news for Atwood because it not only keeps this rig working, but it will also make more money.
That combination of higher oil prices and a rise in dayrates led UBS to upgrade a boatload of offshore drillers last month, including Ensco (VAL), which is in the process of merging with Atwood in an all-stock deal. The bank upgraded Ensco and several peers to buy and raised their price targets due to signs of improving demand for oil rigs and stabilization in the sector. It noted that fleet utilization should slightly improve next year and appears poised to accelerate in 2019 and 2020. That improving outlook suggests that profitability in the sector could rise sharply in the coming years.
Despite last month's big move, Atwood and Ensco are still down more than 25% this year. Consequently, there seems to be plenty of upside ahead, especially considering that Ensco believes its merger with Atwood will enable it to capture $65 million in cost synergies, which should further bolster its bottom line at a time when the industry appears poised to rebound. While it might be a wild ride, that risk could be well worth the reward.