Rowan Companies' attractive asset story (Part 3 of 3)
We believe it is most appropriate to value the company by the pro forma asset quality that represents the source of the earnings transformation and market bifurcations in rig classes. Based on the comps (see below), the implied market values assigned to the UDW fleet of various drillers ranges from $650 to $860 million, with pure-play drillers at the low end due to their credit-specific issues of stress (like Ocean Rig). We know that Rowan is spending $750 million per vessel with 75% of that fleet already contracted and worth roughly $400 million per year in guaranteed EBITDA for the three-year terms (barring a major disruption that leads to downtime or repairs). Yet the market-implied value per drillship is currently $638 thousand—less than the levels of highly levered drillers like ORIG. The story is the same for the core high-spec fleet: a deep NAV discount on the market that is inconsistent with the fleet quality.
On a forward multiples basis, the upside is less meaningful, but still substantial. We believe this is indicative of the relatively uncertain earnings environment past 2015, during which most UDW and jack-up newbuilds in the pipeline are estimated to come to market. A lot of this backlog remains uncommitted and subject to deferral/dismissal and there is a cycle of replacement stock that has to be worked through for aged rigs. Nevertheless, we ascribe meaningful weight to the multiples used.
The DCF is largely an imprecise black box due to the timing of Rowan’s capital cycle, but we nonetheless ascribe some weighting to determine our target estimate of $54/share.
The visibility for utilization begins to blur somewhat once one looks past 2016 to a host of newbuild rigs that remain uncontracted in some cases. Contract terms have come down from five to three years and it seems prudent to expect that day-rates will begin to decline among UDW and premium jack-ups. Rowan does have the advantage of playing in defensible regions like North Sea and recent steps taken to reduce operating downtime provide a greater cushion against potential declines in utilization and day-rates.
Crude is back to its annual 2008 highs and there is no question that E&P spending is experiencing resultant euphoria. There is, however, some historical precedent for oil and gas spending to show resilience to macroeconomic pressures as evidenced by a 15% decline in the face of a 48% decline in crude during 2009.
Rowan’s leading customer is Saudi Aramco (29% of revenue) and the company has a heavy Middle Eastern presence in some potentially volatile areas. In the event of disruption, some rigs may be mobilized to safer regions with open demand and all units in the fleet are adequately insured for loss or damage with a $25 million deductible.
Rowan’s jack-up fleet is the second youngest in the industry (behind Seadrill) and its new drillships are equipped with the latest in redundancy engineering (two seven-ram blowout preventers) to mitigate the risk of a Macondo-like incident.
Rowan is priced at a discount to the inflection point that it currently faces in asset and earnings quality. Its conservative investment-grade capital structure supports execution of a transformative fleet capex program that will bring the company into the lucrative UDW drillship market. There are no hard-hitting catalysts beyond the discernible ship deployments and the market has stood pat as a result. However, the focus on earnings has obscured the quality of the pro forma asset base. Other competitors are being credited for their more aggressive budgets, but we prefer our drillers to be conservative in their capital budgeting, particularly with today’s inverted oil futures curve.
We prefer to get in here early rather than be late to the party.
The Market Realist Take
In 3Q 2013, Rowan reported revenues of $382.8 million, up 8% over the prior-year quarter due primarily to higher average day rates and higher utilization. Net income from continuing operations was $51.9 million (or $0.42 per share) compared to $26.4 million (or $0.21 per share) in the third quarter of 2012. Its out-of-service time was approximately 13% of the available rig days during the third quarter, which was slightly higher than its previous guidance due to the extended out-of-service time for the Gorilla VII leg repairs. The out-of-service time was down from last year’s level because fleet repositioning declined and certain rigs returned to service. Rowan expects out-of-service time for full-year 2013 to be approximately 10% of its available rig days, which is slightly higher than the previous guidance of 9%, primarily due to the extended out-of-service time for the Gorilla VII leg repairs. For 4Q 2013, it expects out-of-service time to be approximately 9% due to off-rig days for the remaining Gorilla VII repairs and shipyard time for the Gorilla VI as it prepares for a fixed contract in Norway.
The company said the operating costs of $212 million for the third quarter of 2013 were slightly higher than its previous guidance and were due to out-of-service time and incremental repair costs because of leg damage sustained on the Gorilla VII. In mid-July, while the Gorilla VII was changing locations, the legs were severely damaged as the hull was lowering into the water. As a result of the incident, the rig was out of service for 82 days in the third quarter, resulting in a loss of revenue of approximately $21 million. During the third quarter, Rowan incurred $9.3 million in repair costs to the rig, which are included in direct operating costs. The rig is expected to return to service in mid-November. Also, rigs operating in high-cost locations added to the company’s expenses. Rowan anticipates operating expenses to be slightly higher—between $212 million and $215 million—in 4Q 2013 as the impact of additional operating days from certain rigs returning to service during the third quarter will offset the expected reduction for the Gorilla VII repair cost. The company expects its on-rig operating costs to increase in 2014 due to more operating days, while off-rig operating costs will increase slightly because infrastructure to support deepwater operations is already in place.
Ocean Rig (ORIG), Noble Corp. (NE), Pacific Drilling (PACD), Seadrill (SDRL), Ensco (ESV), and Transocean (RIG) are also increasing their presence in the ultra-deepwater (UDW) and jack-up drilling segment.
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