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Shares of oil riggers -- the companies that actually do the offshore oil drilling for the big oil names --have been on a roller-coaster over the past 15 months. The Deepwater Horizon oil spill last summer sank stock prices, which then rebounded as investors realized they overreacted, and new regulations proved less costly than expected. Then oil prices took off, pulling the riggers' stock prices even higher.
A unique industry
Oil riggers occupy a singular sector. There are fewer than 10 major players, which might normally suggest an oligopolistic marketplace -- but not here. Despite the concentration within the industry, remember the customer it serves: Big Oil. Even the largest rigger, Transocean (NYSE: RIG) pales in comparison to giant industry customers such as ExxonMobil (NYSE: XOM), ConocoPhillips (NYSE: COP), and BP (NYSE: BP).
As a result, the riggers are price-takers. Assuming a rigger meets safety and reliability expectations, these guys provide a commodity service. Exxon doesn't care who drills its oil (and you don't care at the pump), and it will switch riggers if it can get a better price. And among the riggers, size carries no benefit. Contracts are per-rig, and nothing about having 50 rigs allows a rigger to offer a cheaper per-rig price than a contractor with just five rigs.
In this context, I think it is reasonable to expect that the market will likely value riggers similarly. After all, these companies all do the same thing for the same customers at the same prices, and their size doesn't matter. But riggers' valuations nonetheless vary considerably:
|
Company |
EV |
EV/EBITDA |
P/E |
P/TBV |
Div yield |
|---|---|---|---|---|---|
| Atwood Oceanics (NYSE: ATW) | 3,423 | 9.7 | 12.8 | 2.1 | 0% |
| Noble (NYSE: NE) | 13,490 | 13.1 | 21.3 | 1.3 | 1.7% |
| Diamond Offshore (NYSE: DO) | 10,357 | 6.2 | 10.8 | 2.5 | 4.9% |
| Transocean | 28,084 | 7.9 | 48.9 | 1.5 | 0% |
| Ensco (NYSE: ESV) | 6,931 | 9.1 | 17.0 | 1.4 | 2.6% |
| Rowan (NYSE: RDC) | 5,900 | 11.2 | 19.0 | 1.3 | 0% |
| Seadrill (NYSE: SDRL) | 26,207 | 11.5 | 8.5 | 3.3 | 7.5% |
Swiss operator Noble costs 13.1 times EBITDA right now. Diamond Offshore can be bought for less than half of that. Seadrill sports a P/E of just 8.5, while Transocean commands a multiple just shy of 50 times earnings -- nearly six times higher. You can buy either Noble or Rowan for just 30% more than the value of their assets, but you'd need to pay 230% more than asset value to buy Seadrill. Diamond Offshore boasts a fat 4.9% dividend yield; three of its peers don't pay any dividend at all.
Opportunities in hiding?
To me, this industry is prime hunting ground for a pairs trade. That strategy involves simultaneously buying one stock and shorting a similar stock. Pairs trades remove factors that affect both stocks -- in this case, primarily oil prices, which are outside the riggers' control yet dramatically affect their financial performance -- and instead bet on one rigger relative to another. With the market assigning such disparate valuation multiples to the riggers, we might have a choice opportunity to buy a relatively undervalued rigger and short a relatively overvalued rigger, betting that the two valuations will converge over time.
I'm digging in further for a closer look at each rigger's strategy, operations, and valuation to determine whether they truly warrant their divergent valuations. I suspect that they don't, so look for me to make a judgment on this situation in the coming weeks. The best way to keep up with my thoughts is to follow me on Twitter.
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