We downgraded our recommendation on Rowan Companies plc (RDC) to Underperform from Neutral on Dec 19, 2013. The volatility in the macro backdrop and operational hindrances to the company’s performance in the upcoming quarters can be traced back to the downgrade. Rowan carries a Zacks Rank #3 (Hold).
As per Rowan’s 2013 guidance, contract drilling expenses are predicted to increase by 5% to 7%, while selling, general and administrative expenses are likely to rise by 16% from the last year. Moreover, the company has also forecasted 2014 operating costs to rise by 10% to 11% from the 2013 levels. The interest expense is also expected to rise due to the recent debt issue. As a result, Rowan’s earnings will most likely be affected when these higher expected costs are taken into account.
The company’s ability to favorably renew or sign new contracts will depend on future market conditions. If current newbuilds are contracted at low day rates or if standard jackups remain idle, Rowan’s profitability will go down.
Rowan’s growth momentum might be also affected by the geo-political disruptions in the Middle East, fluctuations in the demand level from consumers and new rules and regulations imposed by the government.
The offshore drilling segment is seasonal, cyclical and susceptible to external shocks that may lead to volatility. Again, there is the possibility of construction delays and cost overruns on new buildings. Operators’ contracts could be cancelled or renegotiated if delays extend beyond a rational time period.
However, the growing demand in the global jackup market with a current fleet-wide utilization of 80% and operating utilization of 86% signify the ever-increasing tendering activity that has raised the dayrates. Rowan in this scenario is positioned advantageously with its several contract rollovers in 2014. The contracts on these rollovers will further help the company in reducing the rig downtime days and provide impetus for increased operations.
Stocks That Warrant a Look
While we expect Rowan to underperform its peers, one can consider Zacks Ranked #1 (Strong Buy) stocks Harvest Natural Resources Inc. (HNR), Blueknight Energy Partners, L.P (BKEP) and Tesco Corp. (TESO) as good buying opportunities for the short term.