For years, satirical late-night TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.
What Pacific Drilling does
Pacific Drilling is an offshore drilling contractor that supplies its ultra-deepwater drilling rigs, equipment, and work crews on a dayrate basis to companies in the Gulf of Mexico, off the coast of Brazil, and off the coast of Africa. Drilling Pacific currently has four ultra-deepwater vessels in service with an additional two projected for delivery this year (second and fourth-quarter), one for delivery in May 2014, and a final vessel scheduled for delivery in March 2015.
In Pacific Drilling's fourth-quarter, the offshore drilling contractor reported $191.9 million in revenue, which was a sequential jump of 11.6% from the third quarter amid an 11.5% boost in revenue efficiency. This was basically the first time all four rigs were in service and the first real indicator Wall Street has had with regard to what Pacific Drilling is capable of. Furthermore, EBITDA increased by 42% to $92.7 million over the sequential quarter as operating expenses fell by $7.2 million, or 9.6%.
Whom in competes against
Pacific Drilling has two primary enemies: politics and a plethora of competition.
By politics, I mean the overall leanings of a government toward whether or not drilling is to be permitted in a particular part of the country or offshore region. The BP (BP -1.26%) deepwater oil spill in the Gulf of Mexico crippled marine life and crushed tourism in the region for months, after an estimated 200 million plus barrels of oil was spilled into the Gulf. Not to mention that BP set aside $20 billion in costs to cover personal and business claims of damage caused directly by its oil spill.
Since then, the U.S. government has been a little more reserved with handing out deepwater drilling permits. Similar qualms about permitting exist in overseas governments, but that often has more to do with royalty rights than anything else.
The other half of the coin has to do with a large number of offshore drilling companies in the Gulf of Mexico and abroad. Don't think for a moment that just because ATP Oil & Gas bit the dust, the drilling landscape has opened up like a buffet, because it hasn't. Ensco (VAL), for instance, has five ultra-deepwater drillships -- not counting its submersibles or jack-up rigs -- that are currently operating in the North American, Brazilian, or African region, taking contracts that could be Pacific Drilling's away from it. SeaDrill (SDRL) currently has three of its four active ultra-deepwater drillships off the coast of Africa and is in the process of having another seven constructed. If that wasn't enough, the mother of all deepwater drillers, Transocean (RIG -3.24%), has a fleet of 20 ultra-deepwater drillships -- that's nearly more than Ensco, SeaDrill, and Pacific Drilling combined -- scattered throughout the world, with a big focus in the Gulf of Mexico.
In short, drilling contracts don't come easy!
After carefully reviewing the prospects for Pacific Drilling, I've decided to make a CAPScall of outperform on the company.
I will admit that oftentimes the rapid growth rates of start-up offshore drillers can be alluring -- one need only look at ATP Oil & Gas to understand the dangers inherent with that. However, Pacific Drilling's net debt of $1.7 billion doesn't seem that daunting, with the operating expenses of its rigs already falling and operating efficiencies rising.
Another factor to consider is the sheer explosion in natural gas and oil field finds in the ultra-deepwater regions around the world. The amount of untapped resources in the Gulf and off the coast of Africa is phenomenal and provides more than enough impetus for the world's largest integrated oil and gas companies to keep exploring and hiring contractors like Pacific Drilling to recover the oil and gas for them.
Don't count out, at least domestically, President Obama's push for a more energy-independent America. Domestic natural gas discoveries in onshore shale formations are going to play a big part in achieving this goal, but even the Obama administration understands how important it'll be to utilize ultra-deepwater energy resources.
Putting this all together gives Pacific Drilling ample opportunities to expand its fleet and become increasingly profitable over the next decade. With expenses well under control and valued at just 12 times forward earnings, with four new drillships expected to be delivered in a span of just eight quarters, I'd call this stock notably undervalued and underappreciated.