The first half of the year has been mixed for offshore drilling stocks with some stocks remaining depressed while others have surged from oversold levels.
Atwood Oceanics (ATW, Financial) falls in the latter category with the stock having surged from deep value levels along with a surge in oil prices. Atwood Oceanics bottomed out at $5.32 on Feb. 2, and the stock subsequently surged by 138% to $12.68 Wednesday morning. Is the stock still worth considering after the big rally?
Several positives in the last few months have translated into upside for Atwood Oceanics. The first factor is more sentiment related as Atwood Oceanics has trended higher along with upside in oil prices. However, this is not the dominant factor in the rally, and the factors that triggered it are as follows:
- Atwood Oceanics was successful in delaying rigs under construction with Atwood Admiral delayed until September 2017 and Atwood Archer being delayed until June 2018. With all milestone payments related to delivery of the rigs also being shifted to later dates, this is a big relief for Atwood Oceanics.
- Atwood Oceanics obtained financial covenant relief until the fourth quarter of 2018, and this is another big positive in challenging times for the company. The leverage covenant ratio has been removed, and the interest coverage covenant has also been removed for the next 2½ years. In the coming quarters, as the EBITDA margin shrinks, credit metrics will worsen, and the removal of covenants is a big relief for the company.
- Atwood Oceanics repurchased bonds worth $154 million in face value at a discount, resulting in a cash payment of approximately $97 million. This was an attractive deal and has supported the stock upside. This has helped in initiating the process of deleveraging, which is likely to continue in the coming quarters.
While these positives have helped Atwood Oceanics trend higher in the last few months, there are concerns that still exist. Because of these concerns, investors should wait on the sidelines before considering any fresh exposure to the stock.
When Seadrill (SDRL, Financial) reported on its first quarter, the management opined that the offshore drilling industry is likely to remain depressed through 2016 and potentially through 2017. The concern for Atwood Oceanics is that the company’s contract coverage for 2016 is 63%, but contract coverage for 2017 is only 23%.
Therefore, if industry conditions do fail to recover, there is likely to be a big slump in revenue and EBITDA for the coming year. The removal of covenants is a relief, but markets will discount the valuation factor if EBITDA slumps.
Another scenario is that the off-contract rigs are contracted, but that is unlikely to happen at a robust day rate. Therefore, EBITDA margin compression is likely in any scenario, and this will significantly change the forward EV/EBITDA valuation.
As markets move into 2017 and if the rigs fail to get contract extension, Atwood Oceanics is likely to witness renewed correction. It would therefore make sense to stay on the sidelines for a stock that has surged in the last few months.
Atwood Oceanics currently has a strong liquidity position of $622 million that includes cash on hand and undrawn credit facility. Further, the company has a modern rig that will fetch strong day rates in good market conditions. However, even with these positives, I would rate the near-term outlook as negative from a stock upside perspective. A positive opinion on the stock is likely only after there is news on contract renewals in 2017.
Disclosure: No positions in the stocks discussed.
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