When it comes to the oil and gas industry, assets matter a lot. There's nothing more important than reserves, rigs, submersibles, and refineries. However, these assets must be capable of generating profitable returns.
Value for money
These returns indicate whether a given company has the capability of using its assets efficiently and profitably. After all, it makes little sense for an exploration and production company to have a lot of acreage, but not the ability to pull out the oil (or natural gas) within. In short, it pays to find out how valuable these assets are to the company.
Here, we will find out whether a given company's assets are profitable and efficient compared to its peers based on some important metrics:
- Return on Assets -- Net income divided by total assets, which shows how much the company is earning compared against the assets it controls. The ratio is an indication of how effectively the company is converting the money it has invested in reserves, property, and other equipment into net earnings. The higher the value, more profitable the assets are. The metric is pretty useful when used as a comparative measure, against peers and also against the industry in general. A value greater than 4.8% is what investors should be looking for in the oil and gas drilling industry.
- Fixed-Asset Turnover Ratio -- Revenues divided by total fixed assets (like plant, property, and equipment). Fixed assets form a major chunk of total assets for companies in this industry. This metric shows how efficiently the company is using its fixed assets to generate revenues. The higher the turnover rate, the better. For these companies a value above 0.6 looks pretty good.
- Total Enterprise Value/NTM EBITDA – This shows how expensive the company is when compared against its earnings before interest, tax, depreciation, and amortization in the next twelve months.
With these factors in mind, let's take a look at shallow-water driller Hercules Offshore (Nasdaq: HERO) and see how it stacks up against its peers:
Return on Assets
Fixed-Asset Turnover Ratio
Source: S&P Capital IQ; TTM = Trailing Twelve Months, NTM = Next Twelve Months.
Hercules Offshore's assets don't seem to generate healthy returns when compared with its peers. Additionally, at -0.6%, its ROA is way below the industry average. Fixed-asset turnover -- though Hercules' is better than some of its peers -- is also below the industry average.
Deeper analysis suggests that the market isn't too confident about the company's growth prospects either, with total enterprise value to forward operational earnings (TEV/EBITDA) at 7.8. This is pretty low compared to some of its peers.
Not surprisingly, the stock is trading below the accounting value (book value) of equity. The market doesn't believe that the company's assets (read: shallow-water rigs) would be in much demand. As a result, Hercules made a loss from continuing operations in the fourth quarter of 2011. Instead, investors are betting big on deepwater drilling. SeaDrill, for example, has a more-versatile fleet of rigs which are capable of drilling in ultra-deepwater and harsh conditions.
Still, management believes shallow water drilling will pay off in the long run. In the wake of the Macondo disaster, the Gulf of Mexico -- a region where most of the company's rigs are located -- is recovering nicely. However, I believe it's a long shot, since companies are moving towards deeper and less-depleted waters.
Foolish bottom line
This isn't the only criterion you can use, although assets generally indicate how oil and gas companies have been faring in terms of operations. You can get a more comprehensive understanding by digging deeper. However, on the surface, Hercules Offshore seems to be a risky proposition.
We at Motley Fool will help you stay up to speed on the top news and analysis on Hercules Offshore. You can start by adding it to your Watchlist.
Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of SeaDrill, Atwood Oceanics, and Hercules Offshore. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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