Will Offshore Drillers Continue to Sink? - Analyst Blog

Being an offshore driller is just not fun right now.

Year-to-date, shares of major companies have significantly underperformed the broader market. In particular, stocks of Hercules Offshore Inc. HERO, Transocean Ltd. RIG, Diamond Offshore Drilling Inc. DO and Ensco plc ESV are down approximately 32.8%, 17.0%, 15.7% and 12.9%, respectively, while the broad-based S&P 500 index have remained flat over the same period. What's more, according to some analysts, the worst is still to come for these drillers.

The most pressing concern for the group, at least in the short-term, will be oversupply in the rig market. With multinational energy biggies looking to reign in their skyrocketing capital expenses, the offshore drilling space is likely to see intense competition, as multiple firms run after a single contract. This excess capacity, in turn, could lead to lower utilization or dayrates.    

Secondly, the offshore contract drilling industry is perceived to be a highly cyclical one and the current thought is that rates had already peaked for this cycle back in late 2013. As the sector looks set to enter a cyclical downturn, drillers will prefer to hold on to their higher technology specification rigs, thereby significantly denting the company's fleet utilization and profitability.

Last but not least, while most of the drillers boast of billion dollar revenue backlogs, they are struggling with idled rigs – or the ones without contracts – in a slack market. On an average, just about two-thirds of available deepwater rigs for 2015 have been able to find customers. Even for this year, a number of drilling rigs remain uncontracted.  

Worryingly, investors do not see an immediate rebound in the sentiment and expect more punishing times ahead. In particular, legacy drillers like Transocean and Diamond Offshore – with their lower-end rigs – look to be in most trouble. This is clearly evident from the high percentage of their float that is sold short. Currently, the short interest ratio in both of them is higher than 6.0, suggesting a considerable level of bearishness. Their Zacks Rank #3 (Hold) also indicates that investors should wait for a better entry point before accumulating shares.

However, one can look at Seadrill Partners LLC SDLP as a good buying opportunity in the offshore drilling space. The Zacks Rank #2 (Buy) firm is associated with a powerful parent like Seadrill Ltd. SDRL, apart from having an attractive yield and a robust near-term growth plan.