Source: Seadrill.
Offshore drilling stocks have been abysmal over the past couple of years. The industry first started experiencing a slowdown in late 2013 after drillers began to notice contract awards were slowing down. That slowdown basically turned into a complete halt last year as oil prices plunged.
However, oil is starting to show some signs of life, and it's causing many investors to wonder if now is the time to jump in and buy beaten-down offshore drilling stocks. Here's what our energy gurus think about that idea.
Bob Ciura: Offshore drillers have been beaten down due to the collapse in oil prices and corresponding reduction in demand for oil drilling equipment, but as tempting as it is to try to pick a bottom, I'm not buying these stocks. I see much better alternatives, even within the oil and gas industry.
Many oil drillers, such as Transocean (RIG 0.96%), have cut their dividends, while others, such as Seadrill (SDRL +0.00%), suspended them entirely. I'd much rather buy a slow-and-steady oil stock like ExxonMobil Corporation (XOM 1.43%), which pays a strong 3.5%, and have complete confidence that its payout is secure. Exxon has raised its dividend for 33 years in a row, including a 6% raise earlier this year.
ExxonMobil's profits are holding up relatively well, thanks to its integrated business. It operates a very large downstream business that actually benefits from lower oil prices as refining costs decline. It's not entirely dependent on high oil prices like the oil drillers. And, ExxonMobil has a fortress balance sheet that helps insulate it from turbulence in the broader industry. It's one of only three U.S. companies to hold the triple-A credit rating from Standard & Poor's.
ExxonMobil has the financial flexibility to keep increasing its dividend in such a tough operating climate because it can cut costs when needed. The company cut capital spending by 12% this year, and in some ways, the integrated majors' gain is an oil drillers' pain. Oil drillers are directly suffering from Big Oil members lowering their capital expenditure budgets.
If the price of oil suddenly recovers, the oil drillers will surely benefit, but so will ExxonMobil. To me, ExxonMobil's relative safety is more valuable than the possibility that oil drillers may have more upside if oil rallies.
Matt DiLallo: I'm going with "it depends." I bought Seadrill right as the market was beginning to turn, and trying to catch an already-falling knife by adding to my position after its stock price collapsed. Suffice it to say, neither purchase has worked out that well.
That said, what drew me to Seadrill in the first place was its very strong contract backlog and young rig fleet. That asset base meant the company would enjoy relatively stable cash flow and wouldn't be forced to retire older rigs. In a sense, it basically enabled Seadrill to avoid the problems currently facing Transocean. However, Seadrill's strong backlog gave it a bit too much confidence, as the company really levered up on debt to fund its growth. That debt has been a real weight on the stock price. It's also making it a much more risky stock to confidently buy since the outlook is just so uncertain at the moment.
Source: Atwood Oceanics.
On the other hand, there is one offshore driller I do like right now: Atwood Oceanics (ATW +0.00%). Not only does it have a robust contract backlog, but it also has a much more manageable debt load. Further, its contract backlog alone can fund its newbuild program, which consists of two drillships that it has already delayed, giving it more time to get contracts. The big risk here is that the offshore drilling downturn lasts through 2016, at which time Atwood Oceanic's backlog will need to be refreshed. However, given its low level of debt, it has a lot more breathing room than its peers, making it the only offshore driller I'd consider buying right now.
Tyler Crowe: I'm going to sound really wishy-washy by giving this answer, but the decision to buy offshore drilling companies really depends more on you than the market itself.
Those of us in the financial and investing media can lay out the land for you. And as you can see from my two other colleagues' responses, there are plenty of differing opinions when it comes to the space. However, the biggest question you need to ask before investing in the offshore rig space isn't whether or not there is a bright future ahead of the industry. Instead, you need to ask yourself whether you have the patience to wait out a tough period in the market that could last a couple years or even more in hopes of a long-term payout.
The other thing to consider when looking at the offshore drilling space is that not all companies are created equal. Two great examples are Atwood Oceanics and Seadrill. Atwood is a more conservative approach to the market. It's relatively well positioned with a newer fleet of rigs and a much more modest balance sheet, but its fleet is quite small compared to some of the other players in the space, and its growth prospects aren't as robust, with just a couple of new rigs under construction. If you are worried about volatility in the market but see some modest opportunity in this space long term, then a company like Atwood is probably more fitting for your investing style.
Seadrill, on the other hand, is more of a speculative bet that the market for offshore rigs will be very strong in years to come and that many of the older rigs on the water will be sent to the scrapyard during this rough patch. It has a very large fleet of brand-spanking-new rigs, and even more on order, but its financial house doesn't look strong today, and recent actions (like suspending its dividend) don't exactly instill confidence. The company is likely to take some hard hits now, but if demand for rigs picks back up in a big way, Seadrill will likely be one of the companies to benefit the most, and its stock could reflect that.
There are a lot of options for you to invest in the offshore rig market, so before jumping into any stock in the offshore rig market, ask yourself, "What kind of company can I handle having in my portfolio?"
