A great sector for value investors right now is the oil and gas equipment and drilling sector. Surprisingly, despite being relatively defensive, the sector is trading at a valuation that is significantly below that of the S&P 500 and its own historic valuation.
That said, a valid concern of investors is that the industry has a limited life span as one day we will run out of both oil and gas. However, peak oil is not expected to occur until after 2020 now the huge shale reserves of the U.S. have been uncovered, so demand should rise during the next few years.
There is some potential for profit in the oil and gas drilling sector, however, care must be taken as not all drillers are created equal.
Oil rig fleets set to expand
Currently the global oil rig fleet is set to expand by 16% over the next 2-3 years, and this is just the rigs on order and under construction right now. Unfortunately, this is going to create oversupply in the market, especially in the market for jack-up rigs and according to Goldman Sachs Group Inc (NYSE:GS), day rates for standard jack-ups are expected to start declining around 2014. On the other hand, the continual drive to find more oil, in more hostile environments, requires rigs with a higher specification and ultra-deep-water drilling capabilities. These are the units that will experience a strong demand and rising day rates over the next few years.
This is where Rowan Companies PLC (NYSE:RDC) steps in and looks attractive to value investors. Currently, Rowan is trading just below its net asset value of $37.9 per share. The company has $2 billion of debt, $1 billion of cash, a net debt to asset ratio of 26% and a current ratio of 6 times – so for the value investor, the company already looks appealing. However, where the true value lies is in Rowan’s future revenue, which right now is somewhat risk free.
Rowan fleet expansion
Rowan Companies PLC (NYSE:RDC) currently has four ultra-high-spec, ultra-deep-water drill ships on order, to be delivered between the end of this year and 2015. These drill ships are already in demand with at least 3 already on multi-year contracts for a day rate of $600,000, easily Rowans most lucrative vessels.
What’s more, these vessels are likely to see sustained demand and rising rates throughout their lives and attracting day rates of $600k plus, on contracts for several years, are likely to add in the region of $800 million a year to Rowan’s revenue—which during 2012 was $1.3 billion so the company is slated to achieve a 60% increase in revenue by 2015.
Rowan has backlog of orders, low valuation, solid balance sheet
Moreover, at the end of 2012, Rowan Companies PLC (NYSE:RDC)’s order backlog stood at a record $3.5 billion, before contracts were signed for two drill ships, so it reasonable to expect that Rowan’s order backlog currently stands in the region of $4 billion, locking in at least three years of revenue – based on 2012 results.
It is unusual for a company that is set to achieve such de-risked rapid growth over the next few years to be trading at such a low valuation, and even discount to the value of its assets. The company has a solid balance sheet, over 90 years of experience behind it and looks perfect for a long-term value investment.