Similar to the equity markets up and down behavior in the first quarter, the stocks in the FPA Fund’s portfolio also exhibited increased volatility. Roughly 75% of the stocks in the portfolio produced positive returns in the quarter while the balance experienced negative results. Interestingly, the energy stocks were both among the best and worst performers in the quarter. For example, Helmerich & Payne, Inc. (NYSE:HP), an on-shore drilling contractor, appreciated nearly 29% in the quarter, but SM Energy Co. (NYSE:SM), an oil & gas exploration & production company, declined 14%. Each of these stocks had their own individual reasons for behaving the way they did, and the overall equity market movement had very little influence on their respective stock prices.
FPA Capital buys Atwood Oceanics and Ensco
We added to a number of existing positions in the quarter and started one new position, which is too small of a position to talk about at this point. Among the stocks that we added to in the quarter were Atwood Oceanics, Inc. (NYSE:ATW) and ENSCO PLC (NYSE:ESV). Both of these companies are off-shore oil & gas drilling contractors.
Atwood Oceanics, Inc. (NYSE:ATW) decreased almost 6% in the quarter as the market became increasingly concerned about the prices the company can charge to rent out its equipment to its customers. Atwood owns off-shore drilling rigs, some of which cost upwards of $600 million apiece to construct today. These $600 million rigs, typically very sophisticated drill ships, allow ATW’s oil & gas exploration customers to drill in the ultra-deep waters (UDW) of the Gulf of Mexico, off the coast of western Africa, or in the deep waters of Brazil. These deep water basins, and other basins, hold the potential to extract over a hundred billion barrels of oil over the next few decades. However, these are very expensive and long-term projects, which not every oil company has access to or the capital to risk. Hence, ATW’s drillships can potentially be rented out to a narrower group of customers than rigs for shallow water drilling (typically four-hundred feet of water depth), where the company’s jack-up drilling rigs operate.
While there are a number of potentially large oil & gas reserves in the UDW, generally 7,500 feet of water or deeper, the timing of when these projects get started can be lumpy. Additionally, Atwood Oceanics, Inc. (NYSE:ATW) is not the only drilling rig operator that sees this very large opportunity, so the company’s competitors have also ordered new UDW drill ships. Thus, the market is concerned about a temporary supply and demand imbalance for UDW drill ships.
In our conservative analysis, we think UDW drill ship rental rates may fall from roughly $600,000/day, which is where day rates were in late 2013, to roughly $500,000 a day. In this downside scenario, Atwood Oceanics, Inc. (NYSE:ATW) would earn close to $5.00 a share this year and over $7.00 a share in 2015 and 2016. This also assumes one of the company’s semi-submersible rigs is idled later this year. With ATW trading in the mid $40s, we believe the risk-to-reward ratio warrants additional capital being deployed in the stock.
ENSCO PLC (NYSE:ESV) declined 6% in the quarter, for largely the same reasons that impacted Atwood. However, ESV has fewer UDW rigs as a percent of its total fleet than ATW, but ESV has more mid-water rigs that could experience lower day rates as newer deeper-water rigs potentially encroach into that space. With ESV’s robust fleet of premium jack-up rigs working in various waters around the world, we expect the company to earn over $6 this year and nearly $7 next year. The company’s current dividend yield is also over 6%, so investors are being paid to wait for a better industry environment. As you might expect, we recently added to our ESV position and would likely add more to the position should the stock weaken further.
FPA Capital sells Oshkosh and Signet Jewelers
Given the increased volatility in the quarter, with periods of stronger performance at the outset of the quarter and richer valuations again in March, we trimmed back a number of positions in the portfolio, but did not eliminate any of the positions.
Among the stocks we reduced in the quarter were Oshkosh Corporation (NYSE:OSK) and Signet Jewelers Ltd. (NYSE:SIG). Both of these stocks also had strong performance in the quarter, with Oshkosh appreciating 17% and Signet Jewelers increasing more than 34%.
See full FPA Capital Q1: Buys ATW, ESV; Sells OSK, SIG in PDF format here.
Via FPA Funds