Why You Should Own This Oil Drilling Player

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

Let me start by saying that I believe in the oil drilling business over the long term. Energy experts have stated that the world’s energy demand will increase fivefold between now and 2050, from 10 Terawatt-hours to 50. While a great deal of demand is likely to be satisfied by cleaner energy sources such as nuclear and solar power, there will still be an enormous demand for fossil fuels as long as supplies exist, which will be further in the future than some will have you believe. However, over the short term, some of the major players in oil drilling are having a shaky year, including Transocean (NYSE: RIG), which happens to be my favorite. Let’s take a look at why I think this one is still a buy, and some others in the space that will also be winners.

Transocean

Transocean is one of the largest offshore drilling contractors in the world. The company has a large fleet of rigs including midwater, deepwater, and ultradeepwater units. Transocean was the owner of the infamous Deepwater Horizon, which exploded while under lease to BP. Ironically, the rig was the subject of some very positive news one year earlier, as the 35,050 ft well established by the rig was the deepest in history and was seen as quite an engineering feat before the disaster. 

With much of the legal implications (but not all) from the Deepwater Horizon spill in the rear-view mirror, investors can finally begin to look to the future. As of the company’s last quarterly report, Transocean had a contract backlog of $28.8 billion, which should keep the company busy for the foreseeable future. 

Another good indicator of the company’s bright future is the recent authorization of a $2.24 annual dividend, which at the current share price represents a yield of about 4.77% per year. Even though this is an excellent yield, it represents less than a 50% payout ratio (based on future earnings projections), which should mean that the dividend will be safe for the foreseeable future. 

Why it’s a good value

Now, it is certainly true that a good yield doesn’t always mean a good value as an investment. Industry experts project improving demand for Transocean’s services, which means higher dayrates paid for the use of their rigs, which is expected to produce revenue growth of 17% next year (2014). Combined with higher cost efficiencies in the company’s operations, this should translate into nice earnings growth over the next few years.

In fact, Transocean is expected to earn $4.32 per share this year, meaning that shares currently trade for 10.9 times 2013’s earnings. The consensus calls for earnings to grow rapidly to $5.83 and $6.35 in 2014 and 2015, respectively. 47% earnings growth over a two year period more than justifies the P/E and also compensates investors very generously for any added risks they take in owning the stock.

Other winners: Oceaneering and Ensco

Oceaneering (NYSE: OII), although not an apples-to-apples comparison, is one of my favorite companies in the drilling sector. Rather than providing drilling rigs, Oceaneering provides engineering services and project management to companies who build rigs. The company’s services include remotely operated vehicle (ROV) services, deepwater intervention and diving services, testing, inspections, and more. Oceaneering is a good play on the expected increase of demand for drilling rigs, as well as the demands that newer rigs meet more rigorous safety standards than they have in the past.

Oceaneering has performed exceptionally well recently, and is up about 56% since the beginning of 2013.  However, the company is by no means too expensive. The P/E of 24.6 times this year’s earnings is justified by the 19.4% and 17.3% earnings growth expected over the next two years. Additionally, Oceaneering has an excellent balance sheet which features more cash than debt.

Ensco (NYSE: ESV) is very similar to Transocean in terms of business model, just slightly smaller. The company is seen as being somewhat riskier, as it is known to construct new floating rigs on speculation, which has paid off in the past. Although Ensco pays a slightly lower dividend yield of 3.47%, shares are pretty cheaply valued right now at 8.8 times this year’s earnings. Using the same growth figure as we did with Transocean, the company’s earnings are expected to grow by 33% over the next two years. This isn’t quite as stellar as the growth that’s expected for Transocean, but this is more than made up for by the lower price of admission.

Final thoughts

Any of these three would make an excellent addition to a portfolio needing exposure to oil drilling. I prefer Transocean for its industry-leading technological position, high yield, and ambitious growth. The hefty backlog doesn’t hurt either (which is about three times the size of Ensco’s, by the way). With Transocean set to report its latest earnings on Wednesday, August 7, pay particular attention to how the company’s backlog is developing and any insight by the company on the few legal implications still hanging over its head.

If you're on the lookout for some currently intriguing energy plays, check out The Motley Fool's "3 Stocks for $100 Oil." For FREE access to this special report, simply click here now.


Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Oceaneering International. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure