Investing in the offshore drilling sector has been my preferred method of gaining exposure to the oil and natural gas industry and profiting from the projected increase in price. Offshore drilling contracts are generally long term and therefore provide the companies with some level of visibility into future earnings. Further the business can be extremely profitable across a wide range of oil prices and is to a certain extent not dependant on the variation in the price of oil and gas.
In this article, I will compare the fundamentals and the valuations of the two major contract drilling companies, namely Diamond Offshore Drilling Inc. (DO) and Noble Corporation (NE). Another major offshore driller, Transocean (RIG) (debt to equity ratio = 0.72), was not considered in this analysis as it did not meet my low debt requirements.
The table that follows presents the fleet composition of the two companies.
Fleet Composition
| Type | DO | NE |
| Semisubmersible Rigs | 30 | 13 |
| Submersible Rigs | 0 | 3 |
| Drillships | 1 | 4 |
| Jackup Rigs | 15 | 43 |
| Total | 46 | 63 |
Diamond Offshore and Transocean (77 floaters) have one of the largest deepwater drilling fleets (semisubmersible rigs) in the world. Analyst expect the deepwater drilling sector to grow faster than the overall oil and natural gas drilling sector which should benefit these companies.
The table that follows provides the company fundamentals for Diamond Offshore and Noble Corp.
Company Fundamentals
| | DO | NE |
| Market Cap (Billions) | $12.12 | $9.22 |
| Sales (Billions) | $3.64 | $3.48 |
| Income (Billions) | $1.37 | $1.59 |
| Net Profit Margin | 37.6% | 45.7% |
| Return on Assets | 28% | 23.6% |
| P/E | 8.90 | 5.90 |
| Projected 5 Year Growth Rate | 20% | 10% |
| Current Ratio | 2.29 | 2.61 |
| LT Debt to Cap | 0.15 | 0.13 |
| Institutional Ownership | 95% | 25% |
| % Price Change YTD* | 48% | 60% |
The EPS estimates for the two companies are shown the table that follows:
Earnings Estimate
| | DO | NE |
| TTM EPS | $9.84 | $6.02 |
| 2010 Average Analyst EPS Estimate | $9.80 | $5.50 |
| 2010 My EPS Estimate (Conservative) | $9.50 | $5.35 |
Using the data from the last four financial years, relative valuation was performed for the two companies and the obtained fair value is shown the table that follows:
Fair Value Calculation
| | DO | NE | ||||
| Existing | Average | Fair Value | Existing | Average | Fair Value | |
| P/E | 8.86 | 20.78 | $214 | 5.98 | 16.36 | $104 |
| P/S | 3.33 | 5.92 | $155 | 2.64 | 4.78 | $64 |
| (P/E) / (P/E – Peers) | 1.34 | 1.24 | $84 | 0.91 | 0.87 | $36 |
| (P/E) / (P/E – S&P 500) | 0.50 | 0.94 | $170 | 0.34 | 0.73 | $82 |
The Call:
Diamond Offshore
I am initiating coverage of DO with a HOLD rating and a 12-month price target of $95. At these levels, DO would be trading at a P/E of 10 representing a 50% discount to its historic levels, but at a premium to its offshore drilling peers. This premium is warranted owing the projected growth rate and the dividend offered by DO. The company has been declaring a quarterly dividend of $1.88 a share yielding 8% a year.
Noble Corporation
I am initiating coverage of NE with a BUY rating and a 12-month price target of $45 derived by applying a multiple of seven to my 2010 EPS estimate. At these levels, NE would be trading on par with its peers.
Disclosure: The author was long DO at the time of posting.
