Why Atwood Oceanics Shares May Be Cheaper Than You Think

Offshore drilling contractor Atwood Oceanics' (ATW) gradual transitioning to ultra-deepwater drilling is a move that the market is yet to appreciate. However, patient investors could find it rewarding in the long run.

While oilfield services companies -- especially offshore drilling contractors -- have been battered by the current environment of low oil prices, discerning investors who are on the lookout for fundamentally solid companies could eventually be rewarded. Of course, that reward will come to only those with an iron stomach for low oil prices and the wherewithal to pick up shares in these solid stocks cheaply when blood is in the streets.

ATW data by YCharts

Small, but right on the money
Atwood Oceanics isn't one of the biggest players in the offshore drilling industry. However, its management has realized where the money is: in ultra-deepwater drilling. The Houston-based company's gross margins have improved significantly as it transitions itself into an ultra-deepwater driller (that is drilling in water depths greater than 7,500 feet) from being predominantly a deepwater and shallow-water driller. The following chart clearly shows that Atwood earns greater gross margins from ultra-deepwater drilling than other areas.

Source: Company filings; CY = calender year.

While drilling costs are no doubt higher in ultra-deepwater drilling, so are the dayrates for these sophisticated rigs. For the uninitiated, the dayrate is the daily revenue earned for renting out a drilling rig to an oil company. Atwood's newest drillships, the Atwood Advantage and the Atwood Achiever, command dayrates of $584,000 and $595,000, respectively . But these high-specification rigs -- capable of drilling in water depths of up to 12,000 feet -- aren't the only ones in Atwood's kitty. The company has two more rigs with similar specifications, the Atwood Admiral and the Atwood Archer, under construction that should be delivered in September 2015 and June 2016, respectively.

And this expansion shouldn't come as a surprise. The ultra-deepwater segment is steadily increasing its share in the total revenue pie.

Source: Company filings; CY = calendar year.

Average fleet age comes down
So confident is management of its strategy that it even went to the extent of taking an after-tax impairment charge of $56.1 million by scrapping a deepwater rig from its fleet, the Atwood Hunter. The Atwood Hunter is a third generation, 1981-built semisubmersible with a water-depth rating of 5,000 feet. This move significantly brings down the average age of the company's 11-rig fleet. And again, the average age of the fleet will go down even further in the next 15 months with the addition of the Admiral and the Archer, respectively.

Decent backlog and no exposure to risky projects
Investors are also concerned about the backlog of contracted days, given the current environment of low drilling activity encompassing the industry. For Atwood, at $2.7 billion, there has been a 25% decline in contracted backlog available as of December 31, 2014 versus twelve months before. However, the good news is that 96% of available operating days for the rest of the fiscal year of 2015 and about 58% days of 2016 are contracted. So I'm not too worried about backlog as of now.

Additionally, there has been no cancellation of future projects till now for Atwood, unlike peers. Last month, Seadrill Ltd. (SDRL) lost a $1.1 billion contract with Brazil's state-run oil company, Petrobras. Earlier this month, Seadril's subsidiary, North Atlantic Drilling lost a five year contract for its West Navigator drillship with Rosneft. But the worrisome part of the news was that North Atlantic now views its $4.1 billion order backlog with the Russian state-run company to be under "significant risk". Similarly, Norway's state-run Statoil cancelled five contracts in 2014 which includes two with Transocean (RIG 2.24%) and one with Diamond Offshore (DO). Recently, analysts at Credit Suisse noted that drillers with exposure to national oil companies run the highest risk of having future contracts cancelled. The good news: Atwood Oceanics has no exposure to state-run oil companies .

Valuation
With a decent backlog, no risky projects and a rig-fleet whose average age has gradually come down, it is no surprise that Atwood Oceanics' stock has performed the best within the offshore drilling industry since June 1, 2014, despite the precipitous fall in oil prices. 

ATW data by YCharts

However, the following table gives us a clear picture on where Atwood stands with respect to its peers.

Source: Yahoo! Finance; ttm = trailing 12 months, mrq = most recent quarter.

Valuing these offshore drillers relatively, Atwood Oceanics comes out among the top. I wouldn't consider the P/E ratio to be an accurate reflector since quite a few companies had impairments and other losses in the last 12 months. However, on comparing the price-to-book ratio, we notice that the market is valuing Atwood's assets to a premium compared to the rest -- except for Diamond Offshore. This isn't a huge surprise given Atwood's modern and high-specification fleet.

But the good news is that Atwood still trades at a discount to most others on an EV/EBITDA basis given its respectable debt-to-equity ratio among drillers. For example, while Ensco and Transocean seem discounted on an EV/EBITDA basis,  their debt levels are higher. The market does not seem to appreciate that and seems to be valuing their assets lower than those of Atwood's. Only Diamond Offshore scores better with all the metrics combined. However I'm inclined toward Atwood, thanks to its juicy 3.6% dividend yield. Atwood initiated its dividend only in September 2014.

Foolish bottom line
There's no way to predict whether oil prices have bottomed, or when they'd be on their way up. However, it's clear that solid companies with strong fundamentals and sound balance sheets will be recognized in due time. Atwood Oceanics is definitely one of them, and may be cheaper than what most may feel. However, savvy investors jump in when others panic.