Despite the strong market, an entire industry has been selling off for what seems to be months now. The valuations are beginning to look very attractive. Is the market serving up a great opportunity or is this a value trap in disguise?
The industry I am referring do is the offshore energy drillers. The market has soured on this group. The reasons abound: weakening rig dayrates, a slackening in the price of oil, leverage -- you name it, and it's happening to the drilling industry.
But the numbers are too compelling not to drill deeper. Transocean (RIG), which is one of the largest and most sophisticated of the oil-and-gas drillers, is now trading at $33, good for a yield of nearly 8%. A dividend this high often means the market believes the dividend will be cut. Transocean's $3 per-share annual dividend translates into approximately $1 billion a year in dividend payments. Over the past three years, funding the dividend has not been an issue because cash flows have been sufficient. The shares now trade at 75% of tangible book value.
Ensco (ESV) seems to have one of the stronger balance sheets in the industry with $4.7 billion in debt vs. $11.5 billion in equity. The shares currently yield 6%. Net income has increased from $600 million to more than $1.4 billion during the last three years. That streak will end in 2014, as the income took a $1 billion expense in the second quarter. Nonetheless, on an adjusted basis, the shares trade for a single-digits earnings multiple and 90% of book value.
Noble (NE) is another interesting one to keep eye on. Recently, the company spun off its shallow water fleet into a new company Paragon Offshore (PGN) drilling. Since the spinoff last month, both parent and spinoff have declined. Noble shares now trade for $24, implying a yield of 5.6% and a market cap of $6 billion. Paragon Offshore could be the more intriguing idea, as the stock opened up at $17.50 and is now trading for just above $6. Last week, the company initiated a quarterly dividend of $0.125 per share, or $0.50 annualized. That's an 8% yield.
I plan to spend the coming weeks looking closer at these companies and understanding their fleets, business models and the anticipated demand. When I look the prices today and the tempting yields, it reminds me of the dry bulk shipping industry several years ago when it was showing very high yields after selling off. Since then, the businesses have been terrible investments, as excessive leverage and shipping rates have decimated the industry. There are significant differences between the oil drillers and shipping companies, but it still doesn't hurt to be a skeptic and then find a gem.