The Best of the Best: Diamond Offshore Drilling and Atwood Oceanics
Alvin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investing in offshore oil drilling makes sense. The ocean covers 71% of the Earth’s surface (NOAA). If one assumes that the distribution of oil underneath the ocean floor is similar to the distribution of oil found inland, then one can see that there is huge potential in offshore oil drilling.
Additionally, the area of the ocean that can be accessed by current drilling technology is large. Since the average depth of the ocean is 14,000 feet, 35.5% of the planet is covered in ocean water that is at a depth of 14,000 feet or less (NOAA). Since offshore drilling companies are currently capable of drilling in 12,000 feet of water, 30% of the planet’s surface is technologically accessible by offshore drilling. This is larger than the 29% theoretically accessible by inland drilling. Thus, it is easy to see why offshore drilling is an alluring business.
Due to this potential and the high demand for oil, there are currently many offshore contract drilling companies. Furthermore, many are expanding their presence. According to the 2011 annual report by Diamond Offshore Drilling (NYSE: DO), it estimates that there are 77 jack-up rigs and 96 floaters scheduled to be delivered between 2012 and 2018. While the increase in rigs creates pressure on day rates, utilization is at 78.7%, which is higher than the 76.6% from a year ago (rigzone).
While many of these companies are highly profitable and would make a sound investment, it is still better to find the best. Since offshore contract drilling is a large industry with no clear market leader, looking for great management is very important. Return on average assets (ROAA) and return on average equity (ROAE) are great metrics for this. ROAA measures how efficiently management uses company assets to generate profits. Similarly, ROAE measures the return management is generating with investors’ money. These two metrics are nearly identical to ROA and ROE except average equity and average assets are used. Anyway, it is more important to focus on ROAA than ROAE because it takes into account the company’s debt. ROAE can be manipulated by overleveraging and ROAA cannot. Also, debt-laden companies are usually bad investments.
The following table lists the pure offshore contract drilling companies with a ROAA of at least 10% in the past 12 months. Ensco PLC (NYSE: ESV) and Transocean Ltd (NYSE: RIG) are included for comparison because they are the two largest offshore drilling companies with 77 and 134 offshore drilling rigs, respectively.
As the table shows, there are only three companies that meet the criteria: Diamond Offshore Drilling, Atwood Oceanics (NYSE: ATW), and Rowan Companies PLC (NYSE: RDC). All three posted impressive numbers, especially for being in an industry that is highly competitive and capital intensive. However, consistency is also important. The following table shows the ROAA of these companies in the last five years.
As shown in the table, Rowan Companies failed to post double-digit ROAA in 2009 and 2010. Thus, we are left with Diamond Offshore and Atwood Oceanics as the only two offshore drilling companies that have posted double-digit ROAA in the past 12 months and in the past five years. This reflects very well on the management of these two companies. So what is the intrinsic value of these two companies?
Diamond Offshore and Atwood Oceanics have a tangible book value of $31.67 per share and $27.31 per share, respectively. Using DCF analysis (assuming perpetuity and averaging capital expenditures), Diamond Offshore and Atwood Oceanics have an estimated earnings power present day value of $42 per share and $36 per share, respectively. Thus, Diamond Offshore and Atwood Oceanics have an intrinsic value of $73.67 per share and $63.31 per share, respectively.
Furthermore, both companies are financially sound. Looking at their balance sheets, Diamond Offshore and Atwood Oceanics have total debts of $1.5 billion and $600 million, respectively. However, Diamond Offshore and Atwood Oceanics have a current ratio (total current assets/total current liabilities) of 5.2 and 2.8, respectively. Thus, they are well positioned and should be financially capable of adjusting to any changes in their industry or the global economy.
In conclusion, the offshore drilling market has a lot of potential. Diamond Offshore and Atwood Oceanics are two offshore contract drilling companies that have performed very efficiently in the past five years. They are the only two offshore contract drilling companies to have generated double-digit ROAA in the past 12 months and the past five years. Furthermore, as was previously estimated, Diamond Offshore and Atwood Oceanics have an estimated intrinsic value of about $74 per share and $63 per share, respectively.
However, there are global risks currently present. First, the issue with the global economy is very concerning. The debt issues in Europe could very well lead to another recession. Lastly, oil has been fluctuating and it is hard to tell where the clearing price will be in the near future. In light of these risks, I would recommend using dollar cost averaging to buy into these two companies.
Alvin has no positions in the stocks mentioned above. The Motley Fool owns shares of Ensco and Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.