Is This Oil Rig Contractor a Bargain?

This article has been adapted from our sister site across the pond, Fool UK.

Oil is essential for modern life. Best known to us as the fuel for our cars and trucks, it is also a key ingredient in many products, including plastics, medicines, and artificial fibers. Oil is also extensively used to make fertilizer, and it could be argued that modern agriculture in large part is a process for turning oil into food.

Drilling for oil costs a lot and oil rigs are very expensive items to own, so the oil industry has separated rig ownership and operation from exploration and production. Specialist firms own rigs, which the oil companies hire when needed. Rig companies have had a tough time since Transocean's (NYSE: RIG) Deepwater Horizon rig exploded in the Gulf of Mexico in April; driller share prices have taken a hammering.

But this means that some drillers' shares look cheap. One such firm is Noble (NYSE: NE), whose shares are on a lowly historic price-to-earnings ratio of 5.2 even though Noble's earnings per share from 2005 to 2009 rose by almost six times. But is it really that cheap?

A bombed-out sector
Noble's shares have been hit hard, falling from $44 in April to $33 (having peaked at $65 in mid-2008). A big contributor to this fall was President Barack Obama banning further drilling in the Gulf of Mexico -- as this represents roughly one-quarter of Noble's business.

Although the ban was overturned in June by a federal judge, we can't assume that this will remain the case. So there is a fairly large cloud over the sector.

I believe that situations like this present an opportunity for investors. It's better to buy something when it's unpopular and unloved, rather than doing so at a time when everyone wants a piece of the action. So rather than buying shares in one of the oil majors, why not consider drillers like Noble?

The business
Noble owns 64 offshore oil rigs, with a further five under construction, which it leases to companies all over the world. You can find a summary of Noble's fleet on the company's website.

Noble has benefited, as you might expect, from the rise in the oil price over the past few years, which caused companies to drill more wells, thus increasing the demand for its rigs.

While there has been a downturn in the demand for rigs, thanks to the drilling ban and the global recession, I take the view that offshore drilling is going to grow significantly in the next decade because, barring miraculous developments in alternative energy, the days of cheap oil are behind us.

Most of the cheaply produced oil has already been found, and with the increasing demand for energy from the newly industrializing nations, this means that high oil prices are going to be here for some time, at least until solar power becomes commercial. 

At $70 a barrel, production from the remote parts of the globe becomes highly profitable, which is why we are seeing Cairn Energy drilling off the coast of Greenland.

An American in Zug
For most of its life, Noble was based in America's oil capital, Houston. However, in 2002 it moved its headquarters to the Cayman Islands and six years later it emigrated to the small town of Zug in Switzerland.

These moves were performed for tax reasons; a big attraction of Switzerland for companies like Noble is lower corporate tax rates. Many companies have changed their domicile in recent years for similar reasons, and several household names have recently made it known that they are thinking of moving.

For example, on Monday the builders' merchant Wolseley announced that it intends to move to Switzerland because the unfair tax treatment it gets in the U.K. means that some of its earnings are taxed twice.

Noble is thus a Swiss company, but its shares are still quoted on the New York Stock Exchange. (Had it not moved, it would still be a member of the S&P 500.

The dividend that isn't a dividend
Noble makes "dividend" payments in an unusual way. "Dividends" are capital repayments, calculated in Swiss francs but then converted to U.S. dollars, and are thus treated as capital rather than income (there are no Swiss withholding taxes on these payments).

Noble makes several capital distributions during the year, in recent years one of these payments has tended to be much larger than the others. The company has announced that its planned distributions for the 12 months from August 2010 will amount to CHF1.08, which represents a 3.3% yield at today's exchange rates.

Show me the money
The key figures from Noble's last five years are summarized in the table below:

Noble's earnings per share for the first half of 2010 were $2.28. If the company manages to repeat this for the second half of the year, it would put the shares on a prospective P/E ratio of 7.3, which is hardly demanding given Noble's recent track record.

Noble has very little debt ($751 million compared to $8.9 billion of assets) and having grown its earnings per share by almost six times in recent years, it now languishes on a low P/E ratio. A share to tuck away for the long haul, methinks.

More from Fool UK's Tony Luckett:

• Wrestle With a 10% Yield
• How Do You Value a Small Oil Company?
• A Pint, a Burger, and a Nice Profit