I have recently been advocating investing in the energy drillers. The group as a whole has been getting pounded in the market, which has led to some intriguing looking valuations. In my previous columns, the theme was more generalized in nature: Own any of the major drillers and, over the next couple of years, prices could appreciate by 75% or more.
As I continue to investigate the industry, I'm now leaning toward some names and shying away from others. While getting into all the major elements of analysis is beyond the scope of this column, one of the key considerations in evaluating oil rig operators is fleet age. And in this particular energy environment, fleet age is critical.
The new rig order book is rather robust as new supply is expected to hit the market over the next several years. Oil companies that are looking at lower oil prices today want to use the most efficient equipment possible. Read: Newer rigs are going to perform far better than older rigs. This distinction is going to be especially critical in the coming year or two, especially if day rates don't improve. Newer, high-specification rigs will command the best possible pricing in a tough environment.
More so, the owners of older rigs will be faced with another dilemma: If older rigs are being contracted out, the decision has to be made as to whether to keep the rig idle or to stack it. Idle means the rig is not being put to work but still has a full crew on board and can be deployed quickly in the event the rig gets contracted out. There is a cost and risk to this strategy, obviously. On the other hand, if the rig is stacked (there is a distinction between hot stocked and cold stacked, but I'll keep it simple here), the rig is basically shut down with no crew.
If a rig is stacked and it's old -- by industry standards, any rig past 30 years is considered on its way out ¿ then the odds are quite good that the rig has seen its final days. To take a stacked rig and make it operational can cost $10 million or more. So you can see the struggle that a company with a generally older fleet will face in the coming years. Absent quality contracts, the older rigs are likely to get stacked, which typically means the end of that rig. In that case, the only hope is monetization or scrapping, which, in the current environment, would create very little value.
Therefore, older rig operators have a huge disadvantage in this market: higher capital expenditures to keep older rigs going, lower contractual day rates and a weak secondary market for the rigs. Cash flows will suffer.
The names I favor today include Noble (NE) and Rowan (RDC). Ensco (ESV) is also a quality pick. All three generally have a relatively young fleet of high specification rigs and good balance sheets that are not overleveraged. Noble, in particular, just concluded a spinoff that basically separated its old rigs into a new company, Paragon Offshore (PGN). Noble got a $1.7 billion cash infusion and was left with a fleet whose vessels average less than 15 years old. That's a very strong advantage heading into this tough market.
Meanwhile, although they are quality companies, Transocean (RIG) and Diamond Offshore (DO) have older fleets and may have a tougher time. Transocean's 10% dividend yield is a huge eye grabber but that will be the first thing to go in a tough market.
It's a tough market for any oil driller today. It's likely that a floor price hasn't been reached yet. The stock prices are now becoming very favorable for significant market beating returns over the next several years, but I would favor those that have younger and more versatile fleets.