North Atlantic Drilling (NADL, Financial) is among the badly-hit drilling companies like Pacific Drilling (PACD, Financial) and Ocean Rig (ORIG, Financial). However, the recent plunge in oil prices has led to a correction in the stock by more than 50% in the past month.
Since my recommendation in May 2014, the stock had surged to $11.39, its one-year high in just two months. The rise was due to the company’s strong fundamentals, and I believe that this correction could be considered a good opportunity to buy the stock with strong fundamentals and robust long-term outlook.
This article discusses some of the key investment positives of the company and why the company will gradually overcome the current market downturn.
Key Investment Positives
Rosneft Partnership
Rosneft's acquisition of North Atlantic’s shares will have a significant impact on the company’s growth. The prime reason for this is the access to the Russian Arctic region. An estimated 150 land rigs is expected to be acquired by North Atlantic from Rosneft in a contract period of five years.
This will help the company to have a local presence in the region and further accelerate the growth. Moreover, the company’s offshore drilling contract of five rigs provides an order backlog of $4.1 billion.
This deal has resulted in 30% partnership stake for Rosneft with Seadrill (SDRL, Financial) still maintaining more than 50% of the shares. Though Russia is dependent on oil prices, the country's economy seems to be in danger. However, I believe the current downturn would be short term and hence the time can be considered as a good entry point for the stock.
Strong Revenue Visibility
North Atlantic Drilling is operational in UK and Norway. However, post its partnership with Rosneft, the company has its huge operations in Russia as well. In the past, the stock has been down due to fall in oil prices. However, a company like North Atlantic Drilling, which generates cash through contracting with oil and gas exploration companies, is not likely to have a direct impact on its revenues due to declining oil prices.
This is primarily because they have their rigs contacted for a specified period of time and thus receive a fixed day rate. If we look at the company’s contractual position, North Atlantic currently has huge contract backlog of $6.3 billion. Most importantly, these are contracted to high quality customers like ConocoPhillips (COP), Exxon Mobil (XOM), and Total (TOT) which ensures stable cash inflows.
If we look at the company’s contract coverage, NADL is un-contracted for just 1% in 2014, 9% in 2015, 25% in 2016 and 31% in 2017. Solid contract coverage for two years ensures sufficient cash inflow for the company.
I believe that the current fall in its stock prices is temporary and the stock would bounce back once the investors are aware of the fact that the revenue of such companies are not significantly impacted with oil price decline (especially with long-term fixed contracts). However, I also believe that the oil prices will move higher, which will help the company to create better coverage and further accelerate the growth.
Source: Investor Presentation
Valuations Also Support Upside
Value investors always look to invest in stocks which have suffered due to market corrections. This provides them as a good entry point to hold a stock with high growth prospects, bearing in mind that the stock is also not fairly valued.
Currently, North Atlantic is trading at an EV/EBITDA of 7.6 and an estimated 2015 EV/EBITDA of 6.6. This is an attractive valuation due to the sharp correction and is an excellent buying opportunity.
I thus believe that once the market realizes the potential of the stock, the company will outperform the industry and the broader index.
Conclusion
North Atlantic Drilling has been punished due to a weak offshore drilling market scenario. However, the stock is unlikely to be impacted by this weakness as the company is operational in specific segments of the industry unlike most of the drilling companies.
North Atlantic operates in the harshest environmental conditions of the North Sea and Arctic regions and the market fundamentals here are different from other offshore drilling rigs. This is because historically, rigs in harsh environment rigs have always shown almost 100% utilization rates with increasing day rates, unaffected by the weakness in the offshore drilling industry as a whole.
Therefore, I believe that the current turmoil is temporary and could be considered a good entry point for a stock with a potential to bounce back with the market realizing its potential.
