Streetwise
Lauren Rudd
Sunday, August 9,
2009
Two of My Favorites in Crude Extraction
There is no disputing the ongoing global requirement for
crude oil. Furthermore, the complexity and expense of locating and extracting
new supplies continues to rise. And while inventory levels and pricing are
subject to the vagaries of the marketplace, with crude once again breaching $71
per barrel, there is a rising interest in companies specializing in crude oil
extraction.
Although the sector can produce substantial investment
returns, the need to ascertain positive earnings and cash flow growth is
critical here. Furthermore, profits in offshore oil drilling are volatile and
that volatility can quickly spill over into a company’s share price.
Yes, share price appreciation can be spectacular. However,
you must have the willingness to underwrite substantial risk. Above all, keep in
mind that wildcatting, or speculative drilling, has DNA similar to that of a
lottery ticket.
Interestingly, the word wildcatting was originally applied to
banking (state banks of old that issued notes they knew could not or would not
be redeemed). The term was dropped from everyday use many years ago, a result of
the National Bank Act of 1863. However, a reemergence as a descriptor of today’s
banking industry might be appropriate.
Returning to the topic at hand, my favorite contract drilling
companies are Transocean (RIG) and Noble (NE), both of which specialize in
offshore drilling and have been discussed here in the past.
Transocean is the world's largest offshore drilling
contractor and the leading provider of drilling management services. The
company's fleet of rigs is considered one of the most modern and versatile in
the world. When I last wrote about the company a year ago, my 2008 earnings
estimate was $12.83 per share. The company posted actual earnings of $13.09 per
share.
Nonetheless, the company’s second quarter numbers
disappointed some on Wall Street. Earnings were $2.49 per share, as compared to
$3.31 a year ago. Revenues came in at $2.882 billion, as compared to $3.102
billion a year ago. However, the shares are still up an astounding 64 percent
since January, while maintaining their strong intrinsic value.
Using a discounted earnings approach, with a 15 percent
discount rate and a 6 percent earnings growth rate, the intrinsic value is $150
per share. The more conservative free cash flow to the firm approach produces an
intrinsic value of $217, against a recent closing share price of $77.60. My 2009
earnings estimate is $13.65 per share with a 12-month target on the shares of
$91, representing a gain of 17 percent.
Noble has a fleet of 63 offshore drilling units, many of
which are capable of operating in water depths greater than 5,000 feet.
Approximately 85 percent of the company's drilling fleet is deployed
internationally. The company’s share price is up 58 percent since January, again
a figure that has a tendency to capture your attention, hence my earlier
black-box warning.
Nobel reported second quarter 2009 earnings of $1.49 per
share, as compared to $1.39 a year ago. The results for the second quarter
include a net after-tax charge of $0.05 per share related to a rig that was
damaged.
Contract drilling revenues for the second quarter were $868
million, up 10.8 percent from a year ago, with a 71 percent gross margin
generating $451 million in net operating cash flow. New capital investment
amounted to $275 million, while debt as a percentage of total capitalization
declined to 11.0 percent from 11.7 percent.
Nobel’s shares also have a strong intrinsic value. Using the
discounted earning approach, with the same 15 percent discount rate and 6
percent earnings growth rate, produces an intrinsic value is $87 per share. The
free cash flow to the firm approach yields a value of $72. The shares recently
closed at $35.07.
My 2009 earnings estimate is $6.50 per share with a 12-month
target on the shares of $41.00, for a gain of 16.9 percent. There is also a
dividend yield of 0.50 percent.
