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Is Now the Time to Get In Too Deep: Part II
Since we last wrote about the deepwater drilling industry in our article “Is Now the Time to Get In Too Deep?” in the summer, amid a period of weaker equity quotations, prices of shares in deepwater companies have generally moved up and outpaced the broader market. This rise has come even as oil prices have gone nowhere in aggregate. Furthermore, general weakness associated with domestic natural gas pricing has persisted, even as gas prices have come off decade lows, which has contributed to lower valuations (such as P/Es) relative to the start of the year at drilling companies. While industry stock valuations are low, operations are showing favorable trends toward improvement. Indeed, this may be an inflection year, as many of these deepwater companies look to be turning the corner in a long-awaited recovery (much as in, say, the housing industry).
Let’s look at TransOcean (RIG), the biggest rig provider. Third-quarter results showed that total fleet utilization went from 58% in 2011 to 73% in late 2012. The company cited more deepwater discoveries worldwide as helping utilization. (Indeed, as discoveries occur across the world, American companies are in a good position to profit.) Meanwhile, earnings from continuing operations were strong as day rates ticked up 3%, year over year.
At Noble Corp. (NE), utilization and day rates are both up. Contract drilling day rates increased 11%, while the amount of revenue days also rose. The company expects another year of heightened capital expenditures, as it invests in the future. Elsewhere, Ensco plc (ESV) recently saw 66% share-net growth. And rig utilization there went from 77% to 84%.
In short, it seems that utilization rates at deepwater drilling companies are edging closer to full capacity; day rates are rising; and capital expenditures are increasing, while balance sheets remain fairly strong. All in all, these cyclical offshore companies look to be regaining their footing.
We reiterate that valuations are low. Take TETRA Technologies (TTI), which provides support for offshore drillers in the form of fluids and services. The company is in the midst of a major restructuring, and is one of the cheaper stocks in our Survey when looking at its P/E ratio. We think increasing rig count and oilfield activity in the deepwater space will likely increase demand for the offerings of its remaining segments, namely its Fluids division. The stock is up more than a third since its recent low during early November, 2012.
As the United States looks set to increase its energy output, this will likely mean more business for oilfield services companies, even if oil prices fall. One critical area is the Gulf of Mexico (part of the golden triangle, along with the coasts of Brazil and Angola). Activity in the Gulf appears to be on an uptrend, and was recently reported at its highest level since the BP-related oil spill several years ago. By one measure, deepwater drilling permits issued for this region are at their highest level since 2007, and are more than double their 2011 level. Here, the major companies like Royal Dutch Shell (RDS/A) or ConocoPhillips (COP) are enjoying a resurgence. Higher oil prices would only increase the activity, and thus profits at oil companies. Meanwhile, companies are investing in more deepwater drilling units. While this may increase the competition for day rates, it also shows the confidence industry executives see in the sector’s performance.
In general, we are seeing deepwater rig counts and day rates increasing, which augurs well for the industry. Positive trends backing these metrics include expanded worldwide exploration and solid oil prices. Momentum may well have turned to the investors’ side in this space, but valuations are still attractive if one anticipates a boom cycle. For more information on the investment merits of each of the oil companies we have mentioned, please see the individual pages for each company. The Timeliness ranks we assign to the petroleum and oilfield services and equipment industries may also be of assistance here.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.