The 2010 oil spill in the Gulf of Mexico delivered a crushing blow to the offshore-drilling industry.
Not only did it cause financial damage in the form of lawsuits and lost revenue, it also took a huge toll on public sentiment. Many investors simply lost their appetite for offshore drillers. That drove big capital outflows from the group, pushing the industry to record low valuations across earnings and cash flows.
But now, almost two years after the spill wreaked havoc in the Gulf, offshore drillers are back on the upswing -- a recent surge in drilling permits from the department of energy is driving demand for offshore drilling services.
This mirrors a larger global trend: Offshore drilling projects in the Gulf are expected to stretch into Cuban and Mexican waters, and new finds off the coast of Africa, Brazil and in the Mediterranean expected to fuel additional demand for offshore-drilling services.
With many exploration and production companies increasing their budgets to capitalize on high crude prices and the big bounce in natural gas in the last six months, capital spending in 2013 is expected to also get a boost. That has analysts at Morgan Stanley projecting a huge year for offshore drillers in 2013.
When you add all these factors together, analysts are projecting 2013 as the beginning of a two-year cycle in which the offshore-drilling industry is expected to grow sales between 13% and 15% annually.
So with many offshore drillers trading at multi-year lows, valuations at record lows and analysts calling for two years of sustained sales and earnings growth, this is the perfect time for investors to jump ahead of the curve and buy offshore drillers while they are still out of favor.
Although there are many good stocks in the drilling space, Diamond Drilling (NYSE: DO), Noble Corp (NYSE: NO) and Seadrill Ltd (Nasdaq: SDRL) to name a few, my favorite is Transocean Ltd. (NYSE: RIG). Here are six reasons why it is time to buy the world's largest offshore driller.
|1. Permits on the rise in the Gulf|
|As I mentioned earlier, the U.S. Department of Energy has issued a lot of deep-water drilling permits in the Gulf of Mexico this year. In fact, it has issued more in the first nine months of 2012 than it has in any year since 2007. Through late October 2012, the DOE has issued 90 new drilling permits for wells deeper than 500 feet, eclipsing the total number of permits issues in the past two years and the two years before the spill. But in spite of these gains, the current total Gulf oil production of 1.3 million gallons per day is still down from pre-spill daily levels of 1.7 million gallons in 2009. This means there's still plenty of slack in Gulf-drilling demand that will benefit an integrated offshore driller such as Transocean.|
|2. Land oil is becoming scarcer|
|Exploring and extracting crude and natural gas is a lot easier on land than it is underwater. But two-thirds of the entire planet is covered with water, forcing energy companies to shift into offshore drilling as wells on land continue to dry up. This is exactly what is happening to some of Saudi Arabia's largest oil fields: A recent report from Citigroup projects the country could run out of oil to export by 2030 as reserves run low after 50 years of heavy production.
|3. An ultra-deep water specialist|
|Transocean is the largest offshore drilling company in the world with a market cap of $17 billion. Although Transocean operates in shallow, mid- and deep-water markets, its bread and butter is the ultra-deep water segment. That makes the company uniquely positioned to capitalize on deeper finds in more exotic locations of the world. These also happen to be the most challenging and highest-paying contracts on the market, making Transocean's expertise and leading market position even more valuable.|
|4. Day rates are jumping|
|The combination of growing number of permits in the Gulf of Mexico and new global projects has pushed day rates for deep-sea rigs higher. In September, Transocean announced a 20-month extension for its GSF Development Driller I, in which its day rate jumped to $580,000 from $522,000. The company also announced its backlog had jumped an impressive $1.7 billion, with $652 million of that total coming on a new three-year contract for its new Deepwater Invictus platform. Scheduled for delivery in 2014, the Invictus secured a robust day rate of $595,000.|
|5. Estimates are surging|
|All of this bullish news is hitting estimates for Transocean hard. Since reporting strong third-quarter earnings of $1.37 per share less than a month ago, blowing past estimates of 76 cents by 80%, analysts have been revising growth projections higher. In just the last 30 days, the current-year earnings estimate is up an impressive 19%, jumping to $3.39 a share from $2.85 a share. Analysts also became more bullish in the long run, with the full-year 2013 estimate to $4.86 a share, a very bullish 43% earnings growth projection. In the next five years, analysts are looking for average annual earnings growth of 21%, well ahead of the industry average of 13%.
|6. A Historically-low valuation|
|But in spite of all the good news, the Street doesn't seem to care much. Transocean is still trading with a ridiculously low valuation. Its price-to-earnings/growth ratio (PEG) of 0.47 is just 35% of the S&P 500's 1.33, below the industry average of 0.67 and below its 10-year average of 0.56. If Transocean were to merely trade with the same valuation as its industry peers, then shares would jump to $66, a 43% increase from current levels.
Risks to Consider: Energy stocks are extremely sensitive to economic cycles and growth. There is still plenty of uncertainty about global growth due to weakness in China and Europe. If the global gross domestic product continues to look soft, then it could fuel further capital outflows from energy stocks.
Action to Take --> Transocean is the undisputed leader in offshore drilling. But shares have fallen sharply in the past 18 months. Don't wait for everyone else to catch on this idea. Buy the stock now, while it's still ridiculously cheap.