Raymond James Lowers Offshore Drilling Outlook, Downgrades Ocean Rig UDW On High Leverage

In a report published Monday, Raymond Jamesanalysts lowered their offshore drilling outlook, as they expect the downturn to continue to be “more severe and prolonged than most are expecting.” In this context, the firm downgraded Ocean Rig UDW Inc.’s ORIG stock from Outperform to Market Perform.

Despite the downgrade, the stock is up almost 10 percent on Tuesday, and now trades around $9.25.

Although Ocean Rig has long been one of Raymond James’ “relatively favored names in the offshore drilling space with strong contract coverage and a high-quality fleet,” it recognizes a bigger investor focus on debt (over assets). “Currently, Ocean Rig sits just below 50% net debt-to-cap, which comes under more stress with the Santorini, two 2017 newbuild rig payments, and rig upgrade plans. Management has guided that it intends to draw $450 million per newbuild delivery, which amounts to $1.35 billion in additional debt. All this pushes the company’s current debt-to-TTM EBITDA from 4x to north of 6x in 2016,” the report explains.

Thus, although the company possesses a high-quality, young fleet, and several medium-term contracts (approximately 71 percent of 2016 is under contract), the analysts feel that “the leverage especially in this environment makes Ocean Rig a riskier story,” and do not expect “replacement cost to be a strong enough backstop.”

Nonetheless, The firm boosted its EPS estimates for the fourth quarter, from $0.70 to $0.73, and now expects earnings above consensus of $0.69 per share. Full-year EPS are now projected at $2.51 per share, up from a previous $2.49, while revenues are modeled at $1.8 billion.