Offshore Drillers: Sales are Nice but Profits are Sweeter
Pam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In a previous article, I discussed the effect of offshore drillers' fleets' age and composition on their sales and backlogs. In this article, I will look at profitability. In a subsequent article, I will address financial condition and debt levels. In response to comments on the last article, I added Noble Corp (NYSE: NE) to my original list of companies: Atwood Oceanics, Inc. (NYSE: ATW), Diamond Offshore Drilling Inc. (NYSE: DO), Ensco PLC (NYSE: ESV), Seadrill Ltd. (NYSE: SDRL) and Transocean Ltd. (NYSE: RIG).
Gross Margin Indicates Cost of Drilling as a Percentage of Sales
Comparing drillers' Gross Margins allows us to see who is paying the least to drill. First, Gross Profit was calculated by subtracting rig operating expenses and reimbursable expenses from total sales. Gross Margin was obtained by dividing gross profit by total sales. Rig operating expenses include those for all the rigs in the fleet, including the idle and stacked rigs, and consist of compensation paid to offshore crews and onshore staff, repairs and maintenance. Reimbursable expenses are incurred at the customer's request and include provision of supplies, personnel and other services.
Fleet age, condition and composition directly affect the cost of contract drilling. High maintenance costs and a large percentage of stacked rigs eat into gross profits and reduce the gross margin. The following table shows the gross margins for the quarter and the trailing twelve months (TTM) ending March 31. Fleet data are from the latest fleet reports as of June 14.
| Ticker | Gross Margin for Qtr ended 3/31/12 | % Change in Gross Margin (Y/Y) | Gross Margin for TTM ended 3/31/12 | Average Fleet Age (yrs.) | % of Fleet Stacked |
| SDRL | 61.5% | 9.3% | 61.4% | 8.4 | 0.0% |
| ATW | 53.8% | -21.3% | 60.8% | 7.3 | 22.2% |
| ESV | 49.3% | 4.9% | 48.7% | 21.7 | 9.6% |
| DO | 46.6% | -12.0% | 49.9% | 26.7 | 12.5% |
| NE | 43.5% | -1.4% | 46.1% | 28.7 | 7.2% |
| RIG | 39.5% | 7.9% | 24.9% | 25.0 | 19.4% |
SRDL and ATW with two of the youngest fleets had the highest gross margins. No explanation was provided by ATW's management in their latest quarterly report for the rather large decrease in gross margin year-over-year (Y/Y)--from 68.3% to 53.8%. However, it would not seem to be due to the fact that two of their nine rigs are cold-stacked because that happened during their 2010 fiscal year which ended September 30, 2010. DO attributed their lower gross margin to the higher cost of operating internationally vs. domestically including the costs of mobilization and moving personnel.
Of these six companies, only SDRL, ESV and RIG grew their gross margins Y/Y.
Of the four companies with the oldest fleets, ESV with one of the lower percentages of stacked rigs, 9.6%, had the highest gross margin at 49.3% vs. RIG's 39.5% with 19.4% of their fleet stacked.
Net Income and Cash Flow from Operations (CFO) Indicate Money Available to Shareholders
Theoretically, Net Income should show how much money is available to shareholders after all expenses are paid. However, net income can be significantly affected by non-cash charges, such as depreciation. This is particularly true for companies with old assets. For this reason, it is useful to compare net income with Cash Flow from Operations (CFO). CFO is calculated from net income by adjusting it for various non-cash items. The following table shows net income and CFO for the 3 months ending March 31 in millions of dollars. The table is ordered by Net Margin (net Income divided by sales).
| Ticker | Net Income for Qtr. Ending 3/31/12 | CFO for Qtr. Ending 3/31/12 | Net Margin for Qtr Ended 3/31/12 | CFO as % of Sales for 3 Mos. Ending 3/31/12 | Net Margin for TTM Ended 3/31/12 | Average Fleet Age (yrs.) |
| SDRL | 439 | 454 | 41.8% | 43.2% | 25.0% | 8.4 |
| ATW | 59 | 99 | 34.6% | 57.4% | 39.2% | 7.3 |
| ESV | 267 | 547 | 26.1% | 53.3% | 23.0% | 21.7 |
| DO | 185 | 350 | 24.1% | 45.5% | 27.3% | 26.7 |
| NE | 113 | 104 | 14.2% | 13.0% | 14.5% | 28.7 |
| RIG | 59 | 540 | 2.5% | 23.2% | -63.4% | 25.0 |
As with gross margin, SDRL and ATW had the highest net margins with their younger fleets.
ATW, ESV, DO and RIG all reported CFOs much higher than their net incomes. For ATW, the improvement was mainly due to a decrease in accounts receivable (money due them from customers); for ESV, it was lower accounts receivable and adding back depreciation; for DO, it was adding back depreciation; and for RIG, it was adding back depreciation and charges for asset impairments.
Collecting accounts receivable is always a good thing. Depreciation is a fact of life — assets age. But impairments in the value of assets acquired is never a good thing. In RIG's case, not only did they take an impairment charge of $227 million in the quarter ended March 31, they also took charges of $5.23 billion and $1.01 billion in the years ending December 31, 2011 and 2010. That $5.23 billion write-off in 2011 was the main reason that their net margin for the TTM ending March 31 was -63.4%.
Return on Assets Shows How Profitably Assets Are Being Deployed
How much is a company earning on its assets? While there is no particular standard, of course, the more the better. Return on Assets (ROA) was calculated by dividing net income by Total Assets.
| Ticker | ROA for Qtr ended 3/31/12 | ROE for Qtr ended 3/31/12 | ROAA for TTM ended 3/31/12 | ROAE for TTM ended 3/31/12 | Average Fleet Age (yrs.) |
| DO | 2.6% | 4.2% | 13.2% | 21.4% | 26.7 |
| SDRL | 2.3% | 6.7% | 5.6% | 16.3% | 8.4 |
| ATW | 2.3% | 3.3% | 11.8% | 16.6% | 7.3 |
| ESV | 1.5% | 2.4% | 5.8% | 9.5% | 21.7 |
| NE | 0.8% | 1.4% | 3.3% | 5.3% | 28.7 |
| RIG | 0.2% | 0.4% | -16.4% | -31.6% | 25.0 |
The top earners for quarter ended March 31 were DO, SDRL and ATW. Return on Equity (ROE) for the same period is also provided and was calculated by dividing net income by Total Equity. While some prefer ROE as a measure of management effectiveness, I believe that ROE should be viewed with caution and always considered together with ROA. The reason is that ROE can be easily inflated by taking on lots of debt since Assets = Liabilities (which includes Debt) + Equity. And excessive debt is not healthy. Dividing ROE by ROA gives you the Leverage, a measure of a company's debt load. Of these six companies, SDRL's debt load is the highest. Debt will be discussed in another article, so that's all I will say now.
Return on Average Assets (ROAA) and Return on Average Equity (ROAE) were calculated by taking the TTM net profit and dividing by the average total assets and the average total equity, respectively, as of March 31, 2012 and March 31, 2011. The investment returns for all six companies declined for the latest quarter vs. the last 12 months (except for RIG, but that is due to their TTM loss). SDRL's returns declined the least.
Bottom Line — when looking at profitability consider five factors: gross margin as a measure of how efficiently a company generates its sales, net margin and CFO as measures of how well sales translate into profits and ROA and ROE as measures of management's effectiveness.
I am long SDRL and have no positions of any kind in ATW, DO, ESV, NE and RIG. The Motley Fool owns shares of Ensco and Transocean. Motley Fool newsletter services recommend 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. If you have questions about this post or the Fool’s blog network, click here for information.
