A comprehensive report is forthcoming. Models available upon request.

UBS: Initiation of US Offshore Drilling Sector
Taking the Plunge, Not Afraid of the Deep

• Initiating sector coverage with a bullish stance. A combination of a strong longer term macro outlook, resilient commodity prices, and attractive valuation leads to our positive recommendation for the U.S. offshore drilling sector. Offshore drillers are highly correlated to oil prices, and we have concurrently dramatically increased our oil price forecast. As the energy cycle continues to lengthen, offshore drillers will be a primary beneficiary.
• Deepwater will thrive with a lengthening cycle. We expect deepwater dayrates to continue to rise through 2011, as demand will continue to outstrip supply despite newbuilds. Reserves per well continue to decline, while the deepwater is one of the few growth opportunities for int’l oil companies that have been effectively marginalized in many regions.
• Rough waters ahead for jackups in 2009? The jackup demand looks strong over the next 12 mos, as the U.S. Gulf of Mexico has incrementally improved. However, we are concerned that dayrates will fall and contract terms shorten in advance of a newbuilds wave in 2H09 as new companies with weaker credit may be less price disciplined.
• Valuation levels extremely attractive for the group. Top picks are Transocean ($201 PT), Noble Corp ($81 PT), and ENSCO Int’l ($85 PT); also have Buy ratings on Diamond Offshore ($160 PT), Rowan ($53 PT), and Atwood ($125 PT); Neutral ratings on Pride Int’l ($49 PT) and Hercules Offshore ($35 PT). We estimate 20-25% upside for the group from current levels, currently trading at 6.4x ’09 EBITDA, 9.2x PE, and a 13% average discount on DCF.

Transocean, Inc., Buy, $201 Price Target
Top Pick: Not Only Bigger, Also Better

• Not only the biggest, but also one of the best. Transocean is by far the largest offshore driller in the world with the largest fleet of deepwater rigs following its acquisition of GlobalSantaFe last year. As we are bullish on deepwater activity levels well into the next decade, we view Transocean as a core holding in the offshore drilling sector. Although near-term integration issues are to be expected, Transocean is one of the best operators in the business and will be one of, if not the, primary beneficiary of rising deepwater dayrates.
• Well positioned fleet with an attractive asset mix. Currently, Transocean operates approximately 70 floaters and 65 jackups with 9 newbuild floaters activating between mid 2009 until 2011. Through this extended cycle, Transocean will be operating a diverse fleet of ultra deepwater, deepwater, harsh environment, and mid-water floater including a particularly high percentage of new generation semisubmersibles and deepwater dynamically positioned drillships.
• Strong operating metrics and balance sheet improvement. With its strong operating metrics and free cash flow generation, we expect debt levels to fall to about 32% in 2009, down from 45% currently. Furthermore, Transocean is likely to divest additional conventional jackups to pay down debt.
• Valuation: Viewed as a core holding. Our Buy rating and $201 price target assumes the stock appreciates to 9.5x times 2009E EBITDA, an expansion from the current 7.5 times multiple and in-line with our DCF evaluation.

Noble Corporation, Buy, $81 Price Target
The Right Assets at the Right Time

• An excellent operator with a sound strategy. Noble has consistently posted strong operating metrics through the cycle by positioning its assets in attractive basins with high quality customers, predominantly NOCs. Noble ranks particularly high on operating margins and free cash flow, while it manages a strong balance sheet.
• Shifting its assets towards deepwater over the next several years. After taking delivery of 3 newbuild semisubmersible rigs over the next several years, revenue will be split evenly between floaters and jackups. We do not expect further newbuild floater announcements as the company appears satisfied with fleet configuration.
• Jackup exposure to North Sea and Middle East. Noble exited the Gulf of Mexico jackup market several years ago as the market softened, repositioned in more attractive markets in the North Sea and Middle East. Although we expect a number of newbuild jackups for sale, we do not expect Noble to participate.
• Valuation: multiple should expand. We rate Noble Buy with an $81 price target that assumes shares appreciate to 8.0x ’09 EBITDA, up from its historical 7.0x multiple. Shares currently trade at a 22% discount to our DCF estimate.

ENSCO International, Buy, $85 Price Target
Not the Flashiest, but One of the Most Undervalued

• Focusing on returns and performance, not technology. ENSCO focuses on strong operating performance with high quality assets, eschewing the highest end technology. We believe the market has underappreciated this company’s financial and operational performance in comparison to other drillers.
• Assets shifting towards the deepwater. With 5 newbuild semis under construction, more than 25% of revenue will be generated from the deepwater revenue, up from only single digits currently. With a simplified design manufactured by a single shipyard, ESV is able to build new rigs for about 2/3rds the cost of competitors. While rig capability will be comparatively less at 8.5k ft water depth, we expect superior returns and shorter payback periods.
• Operating metrics likely to get even stronger. ENSCO consistently posts above average operating metrics with its high operating margins translating into strong return on capital as it has lower capital requirements. Additionally, free cash flow generation should be towards the top of the peer group in future years.
• Valuation: deserves a multiple expansion. We rate ENSCO Buy with an $85 price target that assumes shares appreciate to 7.0x ’09 EBITDA, up from its historical 6.5x multiple. ESV trades at almost a 30% discount to our DCF estimate.

Diamond Offshore, Buy, $160 Price Target
Deepwater Focus with Cash to Spare

• Most deepwater leverage among large caps, but also fully contracted. Almost 90% of Diamond’s revenue is generated from the deepwater, although it has the most number of contracted days in the group limiting earnings upside potential from increasing leading edge dayrates.
• Often criticized for its older fleet. While competitors have spent considerable capex on newbuilds, Diamond has focused on renewing its fleet through upgrades for considerably less capital. Although the company experiences a marginally higher number of unplanned maintenance days, returns on capital are among the best in the group.
• Special dividends as an incentive for investors. Special dividends before quarterly results are becoming an expected part of the story, which we expect to continue with an undercapitalized balance sheet, lower capex requirements, and a majority owner of the company in the Loews Corporation.
• Valuation: More of a value name than some of the others. We rate Diamond Offshore Buy with a $160 price target that assumes shares appreciate to 8.5x ’09 EBITDA, in-line with its historical multiple, but above its DCF of $146.

Rowan Companies, Inc., Buy, $53 Price Target
A Unique Player with an Opportunity

• High end specialty jackups should continue to command premium rates. Rowan holds a unique place in the offshore market with its fleet of high spec jackup rigs that are ideally suited for harsh weather environment and deep natural gas drilling. Despite our concerns of jackup rates rolling over next year, Rowan should be protected as few newbuilds will compete with Rowan assets.
• LeTourneau creates a specialty situation. Sometime this year, Rowan will merge, sell, or otherwise divest its LeTourneau manufacturing business that builds rigs and other rig components. Although the company benefits from vertical integration, a conglomerate discount has weighed on valuation. A merger with another manufacturing company is the most likely scenario with the goal of competing with industry powerhouse NOV.
• Operating metrics lag the group. Rowan’s operating metrics lag the group on many metrics, partly due to its 9 rig newbuild program that has diverted capital and resources. Mgmt also believes it spends more maintenance capital in order to prevent unplanned downtime.
• Valuation: target multiple a bit murky. We rate RDC Buy with a $53 price target that assumes 6.0x ’09 EBITDA, in-line with historical multiple. Our model assumes LTI is a going concern in RDC.

Atwood Oceanics, Buy, $125 Price Target
Riding the Deepwater Wave

• A small cap, but also one of the purest deepwater names. Atwood is one of the smaller cap names of public offshore drillers and predominantly a floater company. With a newbuild semi to be delivered later this year, almost 80% of revenue will be generated from the deepwater. We see earnings upside as this newbuild is uncontracted.
• Smaller scale offset by niche market presence. Although its smaller size gives it less pricing power, it is somewhat offset by positioning assets in niche markets with limited competition. Nevertheless, rigs have less capability in the 2,000-5,000 ft water depth range and tend to receive below average dayrates.
• Undercapitalized balance sheet presents some options. With debt-to-cap ratios in the single digits, Atwood is clearly undercapitalized, especially if it does not exercise a newbuild option this June. Although no discussion at this time, a special dividend appears a viable option.
• Valuation: not as much upside as some of the others. We rate ATW Buy with a $125 price target that assumes 9.3x ’09 EBITDA, in-line with its historical 9.0-9.5x range and with our $122 DCF estimate.

Pride International, Hold, $49 Price Target
Transformed, but Appreciated?

• Finally a pure play offshore driller after divestments. Over the last several years, Pride has transformed itself into a pure play offshore driller after divesting almost $2 bn in assets including land drilling, Latin America E&P, tender rigs, and platform drilling. Mgmt has focused on the deepwater for future growth, reinvesting over $2.8 bn over the last several years.
• Future deepwater growth, but still heavy Gulf of Mexico exposure. Pride currently operates the second largest fleet of dynamically positioned drillships, behind only Transocean, with three more vessels under construction. While future growth will come from deepwater, 40% of revenue is currently from jackups, 80% of which are located in the Gulf of Mexico, both in the U.S. and Mexico, one of the more challenging global drilling markets.
• Will it accept Seadrill’s overtures?. Seadrill recently acquired about a 10% stake in Pride, which we do not view as the purely financial investment that they have indicated. We believe Seadrill has the operational and strategic motivation to attempt a takeover of Pride, however, we sense mgmt may feel this is premature considering the recent transformation of the company.
• Valuation: staying on the sidelines during the special situation. We initiate coverage of Pride as a Neutral with a $49 price target based on 7.9x ’09 EBITDA, in-line with its historical 8.0x multiple. With Seadrill’s stake, shares are now trading at a slight discount to our $55 DCF estimate.

Hercules Offshore, Hold, $35 Price Target
Now is Not the Time for Heroism

• The Gulf is better, but still has a ways to go. Hercules is primarily associated with its shallow water jackup exposure to the Gulf of Mexico, which has been highly susceptible to weak utilization levels and depressed dayrates over the last several years. Improved natural gas fundamentals have resulted in marginal improvement, but we aren’t ready to call a recovery yet.
• Outside of Gulf, other segments offsetting each other. Despite impressions, 60% of revenue is outside of domestic jackups. International jackups and liftboats (35% of revenue) are performing well, but domestic liftboats and inland barge rigs (25% of revenue) are struggling and unlikely to improve much this year, although mgmt appears optimistic of a turnaround.
• What will Pemex do?. Much of the Gulf of Mexico jackup market is waiting on Pemex to announce its drilling budget and subsequent rig tenders for 2008, however, investigations into last year’s rig catastrophe and energy policy debate have resulted in inertia. More tenders than expected will be a catalyst for dayrates/utilization levels, continued inactivity or fewer rigs is a risk. Hard to call right now.
• Valuation: waiting for a better entry point. We rate HERO Neutral with a $35 price target based on 5.8x ’09 EBITDA the midpoint of historical 5.5-6.0x multiple and compares to our $35 DCF estimate. We believe the recent run-up in shares is driven by natural gas-levered service interest and short covering and recommend waiting for a better entry point.

Tags: peak oil energy investments

This entry was posted on Tuesday, April 22nd, 2008 at 3:51 pm and is filed under Transocean (RIG), drilling/service companies. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.