I bought Awilco Drilling in the beginning of 2013 at 90 NOK/share, and after peaking at 162 NOK/share almost three months ago the shares are back to where they started. I was fortunate enough to sell a part of my position near the top, and the big question is of course: is it time to start buying again? Unfortunately the answer is not an easy yes since intrinsic value has been dropping as well. Oil prices are lower, and as a result day rates are also declining.
A glimpse of what is happening with day rates was offered by Transocean last Wednesday when they announced that the Transocean Leader was awarded a four year contract with a day rate of $335,000. The rig was previously operating for $400,000/day for Statoil in Norway on a contract that started in 2012. Since day rates have increased since early 2012 I’m afraid that Awilco’s day rates will drop more than the 16% implied by the new Transocean contract. Awilco is operating under contracts that were made in 2013.
To analyze the impact of various possible future day rates I have created a small DCF model. The two items that have the biggest impact on the calculated intrinsic value are future day rates and the discount rate. With a day rate of $275,000 and a 12.5% discount rate we get today’s share price ($13.80) as fair value:
A $275,000 day rate is 30% below the current day rate. I think this is a bit pessimistic for Awilco since day rates in the UK remained at ~$250,000 even when oil dropped to $40/barrel in early 2009. With day rates at $300,000 the model spits out a value of $16/share while at a $325,000 (representing a 16% discount) fair value per share would be $18. I think using a $300,000 day rate is a reasonable base case. Unfortunately this means that Awilco is probably just slightly undervalued at ~$14/share. So even though the shares have dropped significantly the past months I wont be in a hurry to add to my position.
Disclosure
Author is long AWDR.OL
Some brief comments on Awilco on page 8 of the Forager Funds September quarterly report:
http://www.foragerfunds.com/sites/default/files/report/Forager_QR_Sep_14.pdf
Thanks.
I really enjoy reading your blog. Would it be possible of you to share those excel-templates that you’ve created?
🙂 Would really appreciate it…
I have shared the Google Drive sheet @ this link.
If AWDR is at fair value with your model of a discount rate of 12.5%, does that mean that if I buy today and hold up to 2031 I will have on average a 12.5% each year for the next 17 years assuming everything stays the same ?
In a 1-2 percent inflation world, it looks like a good perspective to me.
Am I correct to say to i’m paid 12.5% carry to be long oil equivalent ?
I could even sell a 1 year 95 strike Call 95 usd on oil to improve this carry if I have a neutral view on oil
Do I make a mistake somewhere ?
Yes, if it’s at fair value with a 12.5% discount rate you are expected to make this return. Hedging this with oil options would be a though task though: dayrates in the UK could move independently from the oil price, and you have the understand that Awilco is a leveraged play. If dayrates go down 10% intrinsic value drops ~17%. That’s why you should demand a healthy discount rate as an investor.
Good thought process. I second the thought on sharing the excel spreadsheet. is the $45M I see recurring every 5 years or so for new BOP and workover? I like that you maintain a conservative day rate, it would be interesting to see if a 2-5% inflation rate on the dayrates impact it seriously…
I have modeled $20 million in SPS costs for each rig every five year, same as the expected cost in 2015/16 excluding the new BOPs. If you want to model an inflation rate on day rates I think you also need to model cost inflation, but it would certainly increase the fair value of the company.
Even though day rates never dropped that low in 2009, my understanding is that vessel supply is dramatically higher now, and new capacity seems to keep coming online.
Almost all new rigs are ultra deep water, not the type of rigs that you would use in the north sea. So it’s unlikely that Awilco needs to compete directly against these new rigs. But if day rates for UDW rigs drop MW rigs will probably follow. It’s certainly connected to some degree.
Have you seen any additional rig supply moving towards the UK market, either new build or a relocation?
Alwilco says that there would be significant costs associated with relocating a rig to the UK? Is it reasonable to think that there will be less supply pressure in the UK market and therefore day rates might hold up better?
Yes, if you check the latest Awilco presentation you see that there are a couple of rigs that are going to move to the UK market in 2014/2015.
Almost half of the Seadrill fleet is ultra deep water, but 88% of them is employed in 0-7500ft (deep, mid or less). To me, this combined with the large backlog of new rigs coming online next year and beyond, Awilco will most likely directly compete with these rigs, the other companies can’t warm/cold stack every new rig as there is a lot of debt involved.
Actually looks like that two UDW rigs are already going to the north sea: the Deepsea Aberdeen is a new built that is rated for 10,000ft and the Bollsta Dolphin will be delivered in 2015 and is also rated for 10,000ft.
No, I do not believe Awilco will directly compete with most of Seadrill’s UDW fleet. Two of the rigs entering the UK North Sea Market (Deepsea Aberdeen and Bollsta Dolphin) were specifically designed for the harsh environment, and are getting ready to operate under long-term contracts that were signed while the rigs were under construction. The Borgny Dolphin is mobilizing in Brazil (contract with Petrobras ended) and getting ready to head to UK for survey and yard work. Keep in mind that the Borgny is also an enhanced rig designed for the harsh environment. I believe the Bollsta and Aberdeen will be operating in the Shetlands area of the North Sea, an area where many of the existing midwater harsh environment rigs in the UK North Sea can not operate.
It may also be instructive to look at the recent contract rate for the Transocean Leader. It is operating in the North Sea off the coast of Norway with Statoil; recently received AoC from Norwegian authorities. Similar age to Awilco’s rigs, capable of drilling in deeper water than Awilco’s rigs, but operating in similar conditions as Awilco’s rigs (harsh environment, <1,000 ft depth).
Thanks for the additional insight. Any idea how many rigs are operating globally that are designed for harsh environments?
Your numbers are in the ballpark with mine. At $14 – $6 in dividends coming our way till the contracts are up, the price certainly appears attractive, but a 33% cut in rates takes dividends down by more than half since the dividends are so leveraged to the day rates.
Also, one of my concerns is that the new rigs that come to the North Sea may be slow to leave. No one crosses an ocean for a short term contract. Barring a significant uptick in new North Sea work, this may take a while to play out.
Yes, the entry barriers are a double edged sword once rigs have moved to the north sea. No idea though how big the impact of a couple more rigs will be on day rates.
Good writeup. Do you think that is overly optimistic for the revenue efficiency assumption? It was a while ago that I looked into this but it seems like most drillers had lower utilization and efficiency. Also, do you think you should model higher interest rates once this debt matures?
Yeah, my revenue efficiency assumption is probably a bit too high although Awilco is currently doing even better. Probably not sustainable though.
Don’t think you should model higher interest rates once this debt matures since just 80 million will be outstanding in 2018. Should be easier to finance than the current 125 million.
Drilling is tough to invest in because it is so sensitive to things that are outside of the control of the management. There is a wide range of what they might earn depending on what dayrates do. I bought this during the decline and now I’m thinking about selling it. But it’s tough to sell something at a 30% dividend yield.
I don’t think that it’s a big problem when a business is sensitive to things that are outside of management control. Just have to size your position accordingly to manage your risk.
Even though this is a cyclical sector, don’t you think that there’s a good chance that the rig-dayrates are higher in 10 years than today? The costs of operating will certainly higher in 10 years (inflation) and assuming that the interest rates won’t be artificially suppressed, the cost of financing will be higher, which means the rig companies will REQUIRE a higher day-rate to service the debt.
While I do think it is probably that dayrates will go up I certainly don’t think that this is required. Drilling co’s might need high day rates, but if they are unable to get them they simply go bankrupt and someone else will be able to acquire the rigs on the cheap, and as a result will be able to make money at very low day rates. As long as day rates are a bit higher than daily opex someone will be able to make some money.
Hi, nice article, very nice blog. Just a few questions.
So you value this stock to about 14 USD which is where its at right now.
Its currently trading at a P/E of 3,58. (60M USD YTD earnings estimated to full year 120M USD and with a 429 USD MCAP)
This kind of shows how bad a metric PE is then, or what is your thoughs on this? Most aspects of the company is good except some risks, but still extremely low PE. Kind of shows PE is completely irrelevant?
thanks
Not a single metric is relevant in every scenario. Don’t think anything is wrong with the P/E metric: you just have to understand when it is relevant, and when it isn’t.
Great write up!
I generally agree with your analysis, however I would build in more conservatism around the utilization assumption. Given their small fleet, if just 1 rig is stacked, it will materially change your per share valuation.
It will be interesting to see how the Hess option works out in Feb-15. I also expect them to reduce their dividend in H2 2015, so there may be a few buying opportunities coming up soon.
Hi, those who pay personal taxes on dividends needs to reduce your figure by tax rate, right?
So for me it would be 13,72*(1-0,26)= 10,15 per share (if i were to use your numbers)
thanks
Yes, if you need to pay taxes on dividends the value of Awilco is lower for you personally. Not possible to work around that using a tax advantaged retirement account or something like that?
Not sure about this, will investigate.
thanks
Hi again, if im not missing something there might be a small error in your excel-sheet calculations. I guess you should add back the Depriciation to your calculation of FCFF and FCFE, right? You already have a capex post.
Correct? This should increase the value quite a bit
thanks
Wouldn’t call that a small error… But you are right indeed!
Nice spot. Always be wary of big models – GIGO :).