Offshore drillers, Diamond Offshore Drilling Inc (NYSE:DO), Transocean LTD (NYSE:RIG), Seadrill Ltd (NYSE:SDRL), Rowan Companies PLC (NYSE:RDC), ENSCO PLC (NYSE:ESV), Atwood Oceanics, Inc. (NYSE:ATW) and Ocean Rig UDW Inc (NASDAQ:ORIG), have not had a good year to date.
The offshore drilling sector is heading into a two year slowdown as oil E&P companies cut spending and an influx of new drilling units hits the market, pushing down day and utilization rates.
For value investors, there are some deals to be found. But while these companies, and indeed the sector as a whole looks attractive based on valuations, there have been some comments from analysts recently that suggest investors could be falling into a value trap.
According to analysts at Barclays:
“…While we continue to remain constructive on the long-term outlook for the drillers, we believe the seemingly compelling valuations for the offshore drillers represent a value trap as we see more near-term earnings risk. Based on current market dayrates for various asset classes, we estimate there is over 30% downside to our current EPS estimates on an adjusted fully-delivered basis…”
“…based on various recent data points which include lower market dayrates, we think there is substantial scope for further downside earnings revisions to consensus numbers…”
With this being the case, Barclays PLC (NYSE:BCS) (LON:BARC) believes that the earnings of some drillers could come in upto 45% below estimates, doubling current valuations.
And further questions have been asked about the quality of offshore drillers net asset values. Indeed, as the sectors outlook deteriorates, and the market gets flooded with new as well as those coming off contract, unable to find new jobs, asset values are likely to take a hit. The resulting write-downs and asset sales at rock-bottom prices will lead to a deterioration in NAV values.
Barclays PLC (NYSE:BCS) (LON:BARC) has more to say on this matter:
“… we continue to believe the market still needs to work through excess capacity and that conditions will get worse before they get better…Companies with larger portions of fleets derived from older assets would be the most impacted. Under this scenario, all companies in our coverage universe…are subject to share price depreciation with an average pullback of 35% …At these levels, we would expect companies with higher leverage levels to be more impacted…”
As a result of these forecasts the bank believes that the average driller could fall 71% until it hits NAV support.
North Sea bright spot for the offshore drillers
The North Sea has been a bright spot for the offshore drilling industry during the past few years. CAPEX in the region has been rising at around 17% per annum for the past five years, great news for offshore drillers and oil service companies.
However, spending within the region is now slowing and while 2014 is shaping up to be another year of growth, planned CAPEX for 2015 is forecast to come in lower for some of the region’s largest E&P players. What’s more, a number of rigs are rolling off contract within the region throughout 2014/2015, which raises a lot of questions about the outlook for rig operators within the region. Rowan has the most exposure to the North Sea, with 32% of its revenue coming from the region.
The burning question
Of course there is also 800lbs gorilla of a question, what about Seadrill’s dividend, which seems to be under almost constant scrutiny by analysts. It would make sense to suggest that the payout will come under pressure as the offshore drilling industry slows, although I will probably receive a lot of flak for saying so.
Analysts at Wells Fargo have covered the payout and their conclusion appears to be similar to that of other Wall Street analysts.
“…It has long been our analysis that [Seadrill’s] aggressive dividend policy has never been funded solely by the operations of its high-quality fleet, but instead has been funded through the sale of i) equity…ii) equity in sponsored “child” entities… and iii) the outright sale of rigs (including sales to its child entities)… As equity and asset values are slipping, we think [Seadrill] may fail to secure the sales prices and external financing required to sustain its current dividend…”
This forecast ties in with Barclays’ prediction that the NAV values of drillers could begin to slide, eroding shareholder value and in the case of Seadrill, putting pressure on the dividend payout.
This is by no means a definitive analysis on the offshore drilling sector but it would seem as if, in general the sector could be heading into stormy waters and investors need to be careful.
Of the companies mentioned, the author is long Rowan Companies.