“I don’t know that you’re ever going to find a CEO who believes his valuation is correct.” ~David Williams
Noble Corporation held an analyst day Wednesday in Singapore and put up their presentation on their website. It’s about 3 hours, so while I’d recommend you listen to it, I think you should pull up a comfortable chair.
Above was David Williams’ quote after being asked a question on where he thinks Noble should be valued. He had been commenting numerous times on the comparison between Noble’s valuation and Ensco’s, and an analyst finally asked about it. It’s clear he still believes Noble deserves a higher valuation from today’s prices… In any event, Ensco has much more visibility in earning power the next year or two because less of their business was affected by the Gulf of Mexico and their rigs didn’t have any downtime, whereas Noble lost 30% of their business during the moratorium. I believe that’s why Einhorn favored them following the Macondo spill (his fund’s biggest position for awhile) and why he wasn’t as big a fan of Noble, even though the companies are very comparable long-term and Noble has been much cheaper all the way since the BP spill. If you compare fleets, they’re virtually identical (this assumes Ensco/Pride merger already took place and newbuilds as part of the current fleet).
Noble vs. Ensco:
- 27 floaters vs. 27 floaters
- 45 jackups vs. 49 jackups
While it is true that Noble’s fleet is slightly older, their floater fleet (which is more profitable than jackups) has better specs across the board. Noble’s management went into granular detail about the two fleets during the presentation & I think you should hear it for yourself on the earnings call.
Age is a serious issue for customers, along with specifications, when it comes to these offshore drilling rigs. Ensco flaunts a graph of avg. fleet age in their latest investor presentation, but they don’t adjust it to be an earnings-weighted average fleet age. As a result, it shows Ensco being 7 years old on average, while Noble shows up at 19 years. However, Noble relies much less upon their older rigs for earning power. Their incoming globetrotters, bully’s, and HHI rigs will constitute a large chunk of earning power, as well as the Jim Day and some of their newer semi-subs and high-spec jackups. The old jackups are what skews the average fleet age, and despite this, many more will get tenders the next few months, according to Noble’s management Wednesday. In any event, it’s best to visualize the 4 classes of jackups that Roger Hunt separated out below. It speaks to the disparity between older & newer jackups and the demand for both today:
As you can see, utilization and dayrates are significantly affected by when a rig was built. The newer ones are getting poached first off the market and then it trickles down- this speaks largely to those drillers aggressively investing in their futures, not only at the jackup but also the floater level. It’s why Ensco & Noble are my two favorites for the industry. I just think they should be valued about the same, perhaps giving Noble a small premium once their earning power is more clear in a 2013 (when many of their newbuild rigs will be delivered). Today, Ensco/Pride trades at $15.5 B, whereas Noble’s at $10.7 B. This 50% disparity is completely unreasonable, but then again, that’s what happens I guess when a situation is difficult to analyze.
So, I want to go back through some of the numbers so you can assess it for yourself. Here are the figures of importance (click for larger picture):
Some things to note are that the op. cash flows are adjusted for working capital changes, maintenance capex is a combination of “other capital expenditures” and “major maintenance capital expenditures”, the operating margins don’t include depreciation/amortization or other non-cash charges, ROA/ROE is based on returns of my definition of “owner earnings” (my op. cash flows less my maintenance capex), and the working capital subtracts out cash.
As you can see, the fleet size hasn’t changed materially over the last decade. What has changed is the profitability per rig, and that has a lot to do with disposing of non-core rigs and building newer high-spec rigs. Return on equity & return on assets are very high, especially for the industry, and a lot of that has to do with the rig selection they’ve made the past five years. 2010 was substantially lower due to the moratorium in the GOM, and this is not going to continue as a good number of permits have been issued already. If you focus on my definition of owner earnings, you’ll see they peaked in 2009 at $1.45 B. Since then, there was the Frontier acquisition and a number of newbuilds being announced as well. Below I’ve listed Noble’s presentation on their floater fleet expansion through 2014:
As I noted before, deepwater floater rigs are much more profitable than their jackup counterparts, and this expansion from 12/13 rigs up to 27 show Noble’s significant growth through the past 2 years. At $1.4 B in 2009 and having 13 floater rigs, having 26 floaters in 2013 will end up much higher, at least approaching $2 B in annual owner earnings in 2013. I realize I don’t have the figures for floater vs. jackup profitability and it’s difficult to assess just how much earning power has been added through the Frontier acquisition, as well as through their newbuild program, but I believe the business will be in very solid shape moving forward with these high-spec rigs.
Moving on, it’s hard for me to quantify all the industry knowledge I’ve obtained the past year from reading so much, but I do know that demand for offshore rigs is as strong as ever and is picking up in various parts of the world. Noble has always stuck to not building any new rigs “on speculation”, meaning they need a firm contract in place before ordering one of these $500+ MM rigs because Noble is the most conservative in the industry. To see them order a few extremely high-spec, expensive rigs on speculation shows me that they have confidence in future demand for offshore drilling.
For example, Noble has a near-exclusive relationship with Shell as their main offshore provider (80+% of drilling), and Shell is filing for permits now to drill 10+ wells off Alaska’s shores. This is a huge development that looks likely to be approved and Noble’s Discoverer will be the first one up there, along with Shell’s Kulluk rig that Noble will operate for them. Shell has already invested over $3.5 B up there in various projects to allow them to drill in Alaska. Another example was Noble’s management discussing strong demand in the North Sea for the latest high-spec jackups, the JU3000N’s, which the customers are now getting up to speed on their new capabilities.
I believe Noble has the best rig selection team in the world as well. David Williams has given numerous examples through the last 2 years of their team going around the world to look at every secondhand rig, each shipyard to work with them on specifications & price, and looking at their existing fleet for possible refurbishments. He said at the presentation Wednesday that the refurbishment & purchasing secondhand rigs has run its course, and that customers are now looking for newer, high-spec rigs for much of their drilling needs. This speaks very well to those companies in this industry with newer rigs being built or currently in place (Noble, Ensco/Pride, Seadrill), and not so well to those who don’t replenish their existing fleets (Diamond especially). I showed the jackup table that Noble provided earlier; it’s another indication that newer fleets will win in the long-run for this industry.
I feel I got a very solid picture of today’s situation in offshore drilling after this long presentation. Management views these tough times as a trough in the drilling cycle and the industry is investing in the next generation high-spec rigs (except for Diamond, who plans on dying slowly by not building any new rigs). Also, finally emerging from this Gulf of Mexico mess will contribute significant industry tailwinds. In addition, management reiterated the $70/barrel that allows offshore drilling to be profitable, and they saw 2010 as a very rough year for them, with much optimism for the next few years.
Overall, Noble has some uncertainty as to 2013/2014 earning power moving forward, but it’s easy to see today’s situation as being significantly misunderstood. With a fleet with better specs than Ensco/Pride’s and being almost identical in terms of size, a 50% discount to Encso/Pride’s valuation is unreasonable and, at the very least, gives today’s investor a significant margin of safety for the future. With a belief in at least $2 B owner earnings in 2013, shareholders can pick it up at a 19% yield to long-term earning power. I continue to believe in this company and it remains as one of my largest holdings, as well as my favorite moving forward.
Also, did I mention? T. Boone Pickens now has Noble as his largest position for his BP fund this latest quarter (more than doubling his position from last quarter from $11 MM to $30 MM)… in my mind this is no coincidence. He sees what I’m seeing and believes in Noble’s current valuation. I think this is the best purchase at today’s prices, except maybe Aeropostale, and shareholders should be very excited for the next 3+ years.
If I were an analyst working for a bank, my recommendation would be “Strongest Buy Possible”. Take a close look into the industry, I think you’ll do well at today’s prices in Noble.