Editor's Choice

Ultra Deepwater Growth Potential

Alvin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Pacific Drilling (NYSE: PACD) is growing. Currently, the company has four drillships in operation and three more under construction. Recently, Pacific Drilling extended, until December, an existing option for construction of its eighth drillship by Samsung Heavy Industries. The company, which was founded in 2006 and went public in November 2011, is growing fast and has a lot of potential.

Currently, Pacific Drilling has a market cap of $2.2 billion. In comparison, the heavyweights in the industry, Seadrill (NYSE: SDRL), Transocean (NYSE: RIG), Ensco (NYSE: ESV), and Diamond Offshore Drilling (NYSE: DO) have $18.6 billion, $17.4 billion, $12.6 billion, and $9.2 billion market caps, respectively. The following table compares the five companies.

<table> <tbody> <tr> <td> </td> <td>Market Cap (billions $)</td> <td>Price to Tangible Book Value</td> <td>Drilling Units</td> </tr> <tr> <td>Pacific Drilling</td> <td>2.2</td> <td>0.9</td> <td>7</td> </tr> <tr> <td>Seadrill</td> <td>18.6</td> <td>3.7</td> <td>67</td> </tr> <tr> <td>Transocean</td> <td>17.4</td> <td>1.4</td> <td>132</td> </tr> <tr> <td>Ensco</td> <td>12.6</td> <td>1.6</td> <td>79</td> </tr> <tr> <td>Diamond Offshore Drilling</td> <td>9.2</td> <td>2.0</td> <td>49</td> </tr> </tbody> </table>

It should be noted, that Transocean recently agreed to sell 38 of its rigs to Shelf Drilling International Holdings for $1.05 billion (Wall Street Journal). Anyway, while Pacific Drilling has a small market cap relative to the other four companies, its fleet is dwarfed in comparison. Looking at market cap relative to drilling units, the other four companies look cheaper. However, not all rigs are created equal. Pacific Drilling makes up for quantity with quality. The company has one of the newest fleets in the industry. Pacific Drilling’s first drillship, the Pacific Bora, was finished in 2010. In comparison, 40% of current rigs are over 20 years old (PACD). In addition, Pacific Drilling has four ships, including three under construction, which are dual gradient drilling capable. Dual gradient drilling simplifies offshore drilling by using two fluids instead of one.

If Pacific Drilling can survive its initial growth phase, investors could have a multibagger in their hands. According to Yahoo! Finance, the Oil & Gas Drilling & Exploration industry has an average Price to Book Value of 1.9. As shown, Pacific Drilling has a Price to Tangible Book Value of 0.9. This means that the company is currently selling for less than its shareholders’ equity. Tangible book value is the same as book value except tangible book value ignores intangible assets like goodwill.

Looking forward, Pacific Drilling and the ultra deepwater offshore drilling industry have a bright future. There is a natural trend to deeper water drilling because, as near shore oil fields are developed, oil companies have to venture farther out into the ocean to find new fields. Pacific Drilling projects that demand for ultra deepwater rigs will exceed supply through year 2014.

In addition, Rigzone states, “Offshore drilling contractors report seeing robust demand for ultra-deepwater rigs worldwide as oil prices and exploration success in basins outside the deepwater ‘Golden Triangle’ spur operator interest in ultra-deepwater drilling.” Similarly, Noble Corp CEO David Williams said, “Operators are seeking longer contracts and looking to pick up groups of rigs for ultra-deepwater drilling contracts, such as BP’s recent three-unit contract award to Seadrill and Noble Corp.” Currently, drillships have a 77.5% utilization rate. This is up from the 73.8% from one year ago (rigzone).

However, Pacific Drilling faces some risks financially. The following table (taken from the company’s current report) shows the company’s total contractual obligations.

<img src="/media/images/user_12906/pacific-drilling-ultra-deepwater-growth-potential1_large.jpg" />

As shown, Pacific Drilling needs to pay a total of about $3.6 billion by the end of year 2016. However, the company only has about $3.1 billion in contract backlog and $812 million in current assets and long term restricted cash. Its contract backlog is detailed in the following table (taken from the company’s current report).

<img src="/media/images/user_12906/pacific-drilling-ultra-deepwater-growth-potential2_large.jpg" />

Using Pacific Drilling’s operating margin of 26%, it can be readily estimated that the company will pile up profits (before interest expense) by the end of 2016 of about $581 million. Thus, Pacific Drilling will be short by about $2.2 billion. However, two of its ships the Pacific Khamsin and Pacific Meltem, which are under construction, are not yet under contract. The two drillships are dual gradient drilling capable so it is likely two will be awarded a contract. Regardless, the financial situation is something that investors should monitor.

In summary, Pacific Drilling has a lot of growth potential. The demand for ultra deepwater rigs is on the rise. In addition, the company has one of the newest fleets in the industry and has four ships that are dual gradient drilling capable. Furthermore, drillships have the advantage (over other rigs) of fast deployment and complete independence. Currently, the company has a Price to Tangible Book Value of 0.9. Since the Oil & Gas Drilling & Exploration industry has an average Price to Book Value of 1.9, Pacific Drilling is worth a look at its current level.

Alvin has no positions in the stocks mentioned above. The Motley Fool owns shares of Transocean and Seadrill, Ltd. Motley Fool newsletter services recommend Seadrill, Ltd.. 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.

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