Will the Downside Continue for Noble Corp?

A bleak outlook for the offshore drilling market could be outweighed by the cheapness of Noble Corp shares.

Vladimir Zernov
Vladimir Zernov
Apr 22, 2014 at 11:00AM
Energy, Materials, and Utilities

This year will be a tough one for offshore drilling companies, and Noble Corp (NYSE:NE) is no exception. The rig market remains oversupplied; Noble itself acknowledges this fact, stating that excessive supply exists in most rig categories.

Meanwhile, large oil companies have been selective in investing their capital, which led to lower rig day rates. As supply continues to outweigh demand, there's little hope for major upside in the near term. 

Older rig fleet
Noble has an older rig fleet than its more aggressive peers like Seadrill (NYSE:SDRL). However, Seadrill's intensive rig-building activity has been bad for the market and pushed day rates down. The situation is worse for older rigs, as they have to compete with a plethora of new ones.

The company decided to address this issue by spinning off several older rigs to Paragon Offshore. Noble plans to launch an initial public offering of about 20% of the company and distribute the remaining 80% of Paragon Offshore shares to Noble shareholders. This move will make Noble's rig fleet younger, but, in fact, Noble shareholders will continue to be exposed to Paragon Offshore's rigs.

Although day rates for Noble’s newest rigs are higher than average, I do believe that the industry needs even higher rates and more contracts to shrug off the pressure on drilling stocks. The Noble Houston Colbert jackup will commence operations for Total at a day rate of $247,000 per day. Noble Sam Croft, an ultra-deepwater drill ship, will start working for Freeport-McMoRan Copper & Gold's (NYSE:FCX) Gulf of Mexico operations at a rate of $610,000 per day. Freeport-McMoRan was very active during the Central Gulf of Mexico Oil and Gas Lease Sale back in March and is ready to expand its oil and gas operations that were acquired last year. This activity is yet to translate into a flood of contracts, as 14% of newest rigs are out of work, according to Rigzone.

Bound to build more rigs
During its recent earnings call, Noble stated that it was reluctant to consider ordering new premium rigs in the near term without a firm customer commitment. Building rigs without contracts for them has been a major problem for the market. Those rigs must be marketed heavily as they arrive from the shipyard. Typically, drilling companies have to make pricing for those rigs more attractive, further pushing market day rates lower.

Noble also stated that it could order rigs without a contract sometime in the future should the market environment improve. From a strategic perspective, the company has to continue renewing its fleet. The market clearly favors new rigs. Noble's latest fleet-status reports reveal that rates for several of the company's old jackups are less than $100,000 per day. Older drill ships are also experiencing significant pricing pressure with day rates closer to $300,000.

As such, companies with older fleets are bound to build more new rigs. Those rigs are entering a market that is already tough. For example, Noble stated that it was searching for work for four of its rigs.

Bottom line
Noble reported solid first-quarter results that beat analysts' expectations, but strategic challenges remain. The current market situation is not favorable for offshore drilling companies. There are too many rigs competing for a limited number of projects. In such circumstances, companies with older fleets are at a disadvantage. Noble decided to spin off its older fleet to a new entity, but this does not solve the overall problem of low day rates.

That said, it's worth mentioning that Noble has gotten cheap and trades at less than eight times its future earnings. This fact, together with a dividend that yields almost 5%, should provide support for the company's shares.