This is the third in a series of articles regarding the outlook for investments in the oil industry in 2006 and beyond.
The energy sector's been booming lately, and nearly every firm in the business is benefiting. But to borrow a quote from George Orwell's Animal Farm, "All animals are created equal, but some are more equal than others." In this case, I think driller Rowan Companies
First, some background
Saying that the oil-drilling sector has been on fire over the past two years is like declaring that the New York Knicks, my pathetic hometown team, are having a subpar season. As of March 3, 2006, the Philadelphia Oil Service Sector Index had climbed more than 112% since the beginning of 2004. That's well ahead of the none-too-shabby 88% gain returned by the major oil companies of the AMEX Oil Index, and it trounces the S&P 500's 16% gain over the same period.
Is the well of profits about to run dry? Not for a Foolish moment. Crude-oil prices remain firmly above $60 a barrel, well ahead of the $56-per-barrel average in 2005 and enough to entice major oil companies to further increase their exploration and production budgets. A recent Lehman Brothers survey of 325 oil and natural gas companies found that these businesses expect to raise their exploration and production spending in 2006 by nearly 15%, to $238 billion. Compare that to the average annual 6%-7% increase of the past 46 years.
Rising exploration and production spending by the major oil companies is good news for the drilling sector. Increased demand drives rig utilization rates higher, which enables drillers to charge higher dayrates. According to RigZone.com, as of March 3, 2006, worldwide offshore rig utilization rates reached 89.3%, up from 88% year over year. U.S. land rig utilization rates look even more impressive; ReedHycalog, an equipment supplier to the industry, predicts they'll hit 97% in 2006, up from 95% in 2005.
Similarly, dayrates for land rigs in the U.S. are now averaging a record $22,000 per day, while offshore rig rates (which vary depending on region and class of rig) have also mushroomed. For example, Transocean's
How does Rowan fit in?
After losing four rigs to hurricanes Katrina and Rita, Rowan currently owns a fleet of 20 premium jack-ups and 18 onshore drilling rigs, not to mention a mini-steel mill, a heavy equipment factory, and a shipyard where it builds its own rigs. (Talk about a competitive advantage!)
Rowan's offshore fleet size might seem like small potatoes compared with the 59 offshore rigs boasted by competitor GlobalSantaFe
According to ODS-Petrodata, the Gulf of Mexico jack-up supply is at its lowest level in 10 years. That's important, since nearly 90% of Rowan's premium jack-ups currently operate in the Gulf of Mexico. As existing contracts for more of Rowan's rigs expire in the first half of the year, the company will be able to charge higher renewal rates due to the quality of its equipment. In fact, according to JPMorgan estimates, Rowan's 2007 earnings-per-share estimates could jump as much as $0.11 per share for every $5,000 increase in Gulf of Mexico dayrates.
Want proof of the first-class nature of Rowan's jack-up fleet? The company reported that dayrates in the fourth quarter of 2005 averaged more than $92,000 per day in the Gulf of Mexico. That's up 24% sequentially, and it's a jump of $41,000 per day, or 82%, from the fourth quarter of 2004. This compares favorably with competitors such as ENSCO and Diamond Offshore
This trend seems to be accelerating. Rowan recently reported that its average offshore worldwide dayrate, Canada and the North Sea included, stood at $134,000 per day. That's up more than 28% since the end of the fourth quarter, and the company believes that rates will likely continue to rise throughout 2006.
Those results are impressive as is, but don't forget that Rowan will have an additional nine land rigs operating by the end of Q2 2006, tossing an incremental $200,000 per day into the revenue pot. Rowan also has four rigs under construction, with one, the Hank Boswell, due for delivery this year. Using some quick calculations, and factoring in the land rigs, these new builds could collectively add 25% to Rowan's earnings by late 2008. The new builds are all premium rigs, such as the Tarzan class or the company's new 240C model, and they should command dayrates greater than $200,000 in the current environment.
Running the numbers
Rowan currently trades at a mere 12 times First Call 2006 estimates of $3.57. That's a 14% discount to the average 14 multiple afforded its peers, and it's 8.4 times 2007 estimates of $5 per share. I believe Rowan's 2006 and 2007 earnings estimates will eventually be revised upward, given the accelerating growth in dayrates.
Rowan has more than $675 million in cash against long-term debt of $550 million, increasing the likelihood that the company will enact another special dividend or initiate a share-buyback program. Furthermore, a blended average of analyst estimates suggests that Rowan will post a 24% return on invested capital in 2006, well ahead of the 14% return estimated for the group in general, and trailing only Diamond Offshore's expected 26% return .Given these factors, I believe energy-hungry investors would be small-"f" foolish not to take a closer look at these shares.
We've struck deposits of further Foolishness:
Fool contributor Will Frankenhoff still enjoys writing for the Fool even more than playing golf. He welcomes your feedback at email@example.com. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.