Atwood Oceanics: Cheap Valuation for the Growth

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It used to be that growth stocks traded at 1x the earnings growth rate. A stock growing at 10% with earnings forecasted at $2 would trade at $20 and in some cases up to 2x that growth rate. In the current climate a stock such as Atwood Oceanics (NYSE: ATW) can trade at virtually half the growth rate.

The company is an under-the-radar global offshore deepwater drilling contractor engaged in the drilling and completion of exploratory and developmental oil and gas wells. The company currently owns 12 mobile offshore drilling units and is constructing three ultra-deepwater drillships and one high-specification jackup.

Atwood is in the middle of an aggressive rig building spree that dramatically expands the fleet that was started a few years back when most companies delayed newbuild programs. The company could reap the rewards of this aggressive program, but the question remains whether investors will ultimately profit considering the market's lack of interest in growth stories.

Q1 2013 Earnings Highlights

The company provided the following highlights for Q1 2013:

  • During Q412 the company earned net income of $72.8 million or $1.10 per diluted share compared to Q312 net income of $95.5 million or $1.45 per diluted share. Last year it had net income of $65.5 million or $1.00 per diluted share.
  • During Q412 the company had revenues of $245.1 million compared to revenues of $252.5 million for the Q312. Last year it had revenues of $184.7 million for the quarter ended Dec. 31, 2011.

Atwood Oceanics smashed estimates for a second consecutive quarter as it reported $1.10 versus estimates of only $0.93. The estimates were exceeded by over 18% in a similar fashion in the previous quarter.

Analysts increased fiscal year 2013 estimates by the corresponding beat in Q1 making logical investors question why the numbers weren’t ratcheted up even more. During calendar year 2012, the company beat estimates by a combined $0.57. This suggests that the high estimate of $5.44 could be more accurate than the $5.02 average estimate.

Valuation

The key to any stock is finding the appropriate valuing method. Using a multiple of the earnings is one of the simplest calculation methods around. Some investors won’t pay more than 1x the growth rate while others will pay as much as 2x the growth rate for fast growing stocks.

In the case of Atwood Oceanics, investors aren’t even willing to pay the stated growth rate. Analysts forecast the 5-year growth rate at 20% suggesting a solid valuation would be 20x the current year earnings estimate of $5.02. That number calculates to over $100 compared to the current price of around $50.

Even more aggressive investors would use the forward earnings for the multiple. Analysts expect earnings of $6.37 in FY14 meaning that in typical markets investors would pay upwards of $124 for this stock. In fact, 2x the growth rate would value the stock at either $200 or $248 depending on which earnings are utilized.

Cheap Sector

Whether reviewing Ensco (NYSE: ESV), Noble Corp (NYSE: NE), or Transocean (NYSE: RIG), the sector in general trades at a cheap value. Investors are clearly concerned that domestic shale drilling will spill over into other countries and eventually zap oil prices. Currently though, Brent oil trades at over $110 while these stocks lag the expected growth rates and other countries are struggling to replicate the shale phenomena in the US. Maybe it turns out that China can repeat the domestic success, but for now the ability is questioned. Demand for deepwater rigs continues to strengthen.

The other three companies are significantly larger than Atwood Oceanics with an average market cap of over $10 billion. Transocean is well known for the Gulf of Mexico well explosion, but the company is finally making a rebound. Analysts expect earnings to soar in 2013, but the company lacks revenue growth.

Analysts expect much higher growth at Ensco and Noble in 2013. In fact, Noble is expected to grow revenue by over 20% the next two years. While all of the stocks offer varied levels of focus on deepwater drilling, Atwood Oceanics offers the combination of the fastest growth and lowest multiples. 

The chart below highlights the extremely low earnings multiples in the sector.

ATW Forward PE data by YCharts

Worth noting is that the current year earnings multiples of Noble and Transocean drop into the 10-11 range once the numbers roll to 2013 as the current year.

Conclusion

The perplexing part with the sector is that investors apparently disagree so much with analysts. Either the companies will meet the expected estimates or not. If investors really expect a big discrepancy than analysts should adjust the expectations.  

Part of the benefit to investing in this sector is the long-term contracts. Generally the deepwater rigs sign contracts for at least 3 years and in some cases up to 6 years.  In that scenario, most of the earnings estimates are already locked in for the year. This scenario makes the current valuation even further perplexing. Investors should take a look into Atwood Oceanics as long-term contracts, high oil prices, and new rigs should guarantee huge profits for the next few years.


Mark Holder and Stone Fox Capital Advisors, LLC have a position in Atwood Oceanics. The Motley Fool recommends Atwood Oceanics. The Motley Fool owns shares of Atwood Oceanics. 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!

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