People. Ideas. Success. Guggenheim Securities, LLC Oilfield Services, Offshore Contract Drillers & Capital Equipment November 13, 2014 Floater Attrition Forecast: A Potential Inflection Point Darren Gacicia (212) 293-3054 [email protected]GUGGENHEIM SECURITIES, LLC See pages 43 - 44 for analyst certification and important disclosures. This report is intended for [email protected] at Guggenheim. Unauthorized distribution of this report is prohibited.
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2014-11-13_Floater Attrition Forecast - D. Gacicia
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GUGGENHEIM SECURITIES, LLC See pages 43 - 44 for analyst certification and important disclosures.
This report is intended for eric.w.loyet@
guggenheimpartners.com
at Guggenheim
. Unauthorized distribution of this report is prohibited.
Floater Attrition May Be a Potential Positive Catalyst for the Group Floater Market Forecast: Introduces Rig Attrition, Flat Demand, Market Utilization Bottoming in Low 90s %, & Scenarios for Upside. We are recalibrating our
floater market assumptions, forecasting that 58 total floaters leave the market by the end of 2016 (70 by 2018, pgs. 3-6), versus no retirements previously, and assume a
flat demand forecast amid limited visibility, versus demand growth previously. Limited slackening of the floater market to 90+% marketed utilization under a flat demand
outlook, although not a clear bullish signal, suggests a better outcome than the current market forecasts and more stable dayrates. In our view, announcements of rig
stacking and retirement will mark a bullish shift in the sentiment around floater market balances and likely a bottom in offshore driller shares. Under a flat forecast for
contracted rigs (currently 280, pg. 12) and our rig attrition forecast, utilization of marketed rigs falls from a current ~94% to ~92% at the end of 2016 (pg. 3), as attrition
largely offsets the arrival of newbuilds. Given plausible scenarios for low single digit (2.5%) demand growth and potential for delays or cancellations of Brazilian-built
newbuilds, the market may tighten and investor sentiment could shift quickly. We believe the stocks are likely near bottom and range-bound into year-end, as negative
investor sentiment reigns, but patient investors should build positions at current levels (see favored stocks below). If rig attrition trims supply, upstream budgets surprise
(better rig demand growth), and the oil outlook becomes more balanced (political/fundamental reasons), offshore driller shares may outperform in 2015.
Flat Floater Demand Forecast Conservative vs. Recent History. Firm contracted demand through 2015 for development work (pg. 21), a fall in exploration activity back
to historical averages (pg. 20), and limited near-term visibility around capital budgets supports a flat 2015 demand assumption. No growth beyond 2015 may prove
conservative versus historical trends. Historically, development drilling growth has been resilient through commodity volatility, as offshore basins remain important for new
source production. Our most recent demand forecast (pg. 14-16) must be revisited, as high growth, project-by-project data from consultant sources must better factor the
outcomes of a cautious capital budgeting cycle in addition to our probability weighting (“Second Derivative” Leads Drivers, Despite Near-Term Dayrate Headwinds,
6/2/14). Although 3Q14 industry comments temper offshore spending expectations and suggest project delays, favorable marginal cost economics for a large number of
projects (pg. 18) and the push for standardization indicate oil companies look to press forward with projects.
Two Plausible Bullish Scenarios May Turn the Market in 2H15/1H16 (pg. 3):
Growth Can Change Dynamics Quickly. A low single digit demand growth forecast (2.5%/year) remains plausible (pg. 3). Even small growth, in addition to rig attrition,
may tighten the market via an inflection in utilization, and turn market sentiment. For the last ten years, the number of contracted floaters grew at a 6-7% CAGR (pg.
19), largely driven by the search for larger scale reserve replacement and production growth. The advent of unconventional plays has not derailed the trend, but the
quest to lower breakeven costs has slowed activity and started the industry up the learning curve within the deepwater frontier, toward an establishment of best
practices and standardization. A flat growth forecast works contrary to historical trends and the need for oil companies to generate cash from offshore assets, if a
better ROIC, production growth, and dividend sustainability remain IOC goals.
Brazilian Floater Delays May Significantly Change Supply Dynamics. If the 28 newbuilds scheduled for construction in Brazil (9 by 4Q16) are delayed or do not come
to market, marketed utilization may improve dramatically (pg. 10). Only 13 of these rigs are under construction at shipyards with participation from established players
(Keppel FELS & Jurong). The remaining shipyards are under construction themselves. Probability favors Brazil rig delays/cancellations as a tailwind.
Drawing the Line in the Fleet: Multi-Factor Rating Methodology. We have constructed a proprietary multi-factor model to assess the floater fleet by capability, age, and
free date in order to create a ranking for each rig, retirement list and schedule (pg. 7). From the analysis we have derived a list of 71 rigs set to leave the market (pg. 9),
most in addition to those already idle/not contracted (47, pg. 12). We see 4Q14 as a significant attrition period, with 13 rigs leaving the market, of which 6 are currently
uncontracted. In our view, our retired rigs will leave the marketed fleet and drive marketed utilization higher, but may be counted in the fleet until scrapped, lowering the
optics of total fleet utilization despite no longer competing. Several offshore drillers have begun to announce rigs as stacked, retiring, or held for sale, while others have
suggested retirements are to follow. We see strategic reasons for offshore drillers to be coy in identifying rigs until they formally leave the market, but maintain the view
that rig retirements are on the horizon and will serve as positive catalysts for sentiment. We believe RIG (BUY, $27.08), DO (BUY, $35.84), and ESV (Neutral, $39.27) will
see the most retirements (pg. 8), but these are largely factored into our models and appear to be discounted in their share prices.
Favored Offshore Drillers. In our coverage, we believe SDRL (BUY, $21.27) and RIG (BUY, $27.08) have the most leverage to the more bullish offshore driller outlook,
especially if capital markets remain open to financing newbuild deliveries and fleet renewal, respectively. Post PGN spin and recent announcements, NE (BUY, $21.54)
continues to screen better with a solid cash flow story with catalysts around the MLP and share repurchase prospects. In the small/mid-cap names, we continue to like
PACD (BUY, $6.87) and ATW (BUY, $35.52) for quality of fleets, longer-term growth stories, and emerging payout strategies.
Oilfield Services, Offshore Contract Drillers & Capital Equipment PAGE 6
Multi-Factor Rig Ranking Methodology
Our floater factor-weighting methodology ranks each rig against every rig in the floater universe. Each rig is percent
ranked against the universe on the below factors, with the overall ranking as an average of the category ranks.
Double counted
due to being
significantly
differentiating
factors that are
difficult/expensive
to change.
Rig Ranking Methodology
Source: Guggenheim Securities, LLC
Factor Description Weighting
Water Depth The rig's maximum operating water depth. A deeper depth ranks higher. Standard
Drilling Depth The rig's maximum drilling depth. A deeper depth ranks higher. Standard
VDL (Variable Deck Load) The variable deck load represents the carrying capacity of the rig. A greater capacity ranks higher.
Double
Derrick/Hook Load Maximum weight the derrick/mast and substructure can handle. A greater maximum load ranks higher.
Double
BOP Rams (Blowout Preventers) Total count of BOP rams onboard. BOP rams are designed to help prevent blowouts and are important for the safety of the crew, environment, and rig. More rams rank higher.
Double
DP (Dynamically Positioned) A dynamically positioned rig employs computerized thrusters to keep a rig positioned correctly at all times. Dynamically positioned is a binary measure with a DP system ranking positively.
Standard
Dual Activity A rig with two drilling packages to allow for greater efficiency. A binary measure with dual activity ranking positively.
Standard
Rebuild Credit is given to rigs that have been rebuilt. Standard
Generation Rig generation is based on the rig's initial delivery year. Newer generation rigs rank higher.
Standard
YIS (Year in Service) Year in service represents when a rig first began working. Newer rigs rank higher.
Helm & Payne HP Neutral 85.56 (634) 8,626 0.1 1,559 1,822 - 5.5 4.7 NA 10.22 11.65 - 8.4 7.3 NA (2.01) -2.4% NA NA
Nabors NBR Neutral 17.24 3,470 8,460 2.2 1,800 2,327 - 4.7 3.6 NA 5.20 6.69 - 3.3 2.6 NA 0.09 0.5% NA NA
Patterson UTI PTEN Neutral 21.64 567 3,736 0.7 985 1,247 - 3.8 3.0 NA 5.83 7.22 - 3.7 3.0 NA (0.75) -3.5% NA NA
Seventy Seven Energy SSE Buy 11.73 1,564 2,161 3.3 481 589 675 4.5 3.7 3.2 7.14 9.27 10.48 1.6 1.3 1.1 1.90 16.2% NA NA
Mean 4.6 3.8 3.2 4.3 3.5 1.1 2.7%
*Quarterly EPS figures for ATW and HP reflect calendar year reporting basis. NAV figures for Offshore Drilling companies are Break-Up NAVs. In $m except per share data.
Oilfield Services, Offshore Contract Drillers & Capital Equipment PAGE 36
OFS Valuations & Risks
Source: Thomson Reuters, Company Reports, Guggenheim Securities, LLC
` Ticker Valuation Risks
BHI BHI currently trades at approximately 13x our 2014 EPS and 6x our 2014 EBITDA estimates. Our 12-month
price target of $72 is based on 15x our 2015 EPS and 6.5x our 2015 EBITDA estimates.
While w e believe that current consensus capex is still achievable even if WTI averages $85/bbl next year, and w hile w e note that BHI has several
buffers w hich should protect its 2015 earnings grow th, w e submit that another prolonged leg dow n in oil prices due to domestic or international
factors w ould likely put E&P spending at risk, and therefore our estimates may prove too high.
HAL HAL currently trades at approximately 14x our 2014 EPS and 7x our 2014 EBITDA estimates. Our 12-month
price target of $75 is based on 10.5x our 2015 EPS and 8.0x our 2015 EBITDA estimates.
In our view , the risks to the stock are all macro related right now . As our “Picking Up the Pieces” report of October 20 pointed out, should the price
of WTI collapse and average $75/bbl or less next year, the organic contraction in E&P spending w ould be an estimated 18%—a gap vs. current
consensus that w ould be too w ide to close w ith incremental debt. Under this scenario, w e believe N American earnings w ould fall by roughly one-
third (to the 1H13 level), removing roughly $1.00 from our current 2015 EPS estimate. Additionally, HAL maintains a relatively high level of exposure
to Iraq; consequently, should the conflict w ith ISIS interfere w ith operations (as it did during 3Q14), EPS could be adversely impacted.
SLB SLB currently trades at approximately 18x our 2014 EPS and 10x our 2014 EBITDA estimates. Our 12-month
price target of $125 is based on 19.5x our 2015 EPS and 11.5x our 2015 EBITDA estimates.
Much of the investment thesis for SLB rests w ith its ability to grow market share by delivering superior services quality and tool reliability, and
reduce the cost of services delivery. To the extent that execution of this strategy takes longer than w e currently expect, our estimates—especially
margins—could prove too aggressive. Similarly, SLB’s human resources program has long been a competitive advantage, and to the extent that the
company loses key people (particularly to IOCs), its competitive positioning in the industry could w eaken.
WFT WFT currently trades at approximately 14x our 2014 EPS and 7x our 2014 EBITDA estimates. Our 12-month
price target of $25 is based on 15.0x our 2015 EPS and 7.5x our 2015 EBITDA estimates.
Over the course of this year, WFT’s progress on its transformation initiatives has led it to begin to improve margins and cash flow w hile shedding
underperforming businesses, allow ing it to begin to trade more in line w ith peers; how ever, should commodity prices encounter any w eakness due
to crude saturation in North America, or should WFT be unable to execute on its remaining divestitures in a timely manner, multiples may begin to
compress again and our estimates may prove too high.
CAM CAM currently trades at approximately 15x our 2014 EPS estimate and 8x our 2014 EBITDA estimate. Our 12-
month price target of $75 reflects a multiple of 12.4x our 2015 EPS and 8x our 2015 EBITDA estimates.
In addition to the obvious macro risks, w e believe CAM has several company-specif ic risks. For instance, Drilling Products still make up about one-
third of the company’s revenue, and new orders for offshore rig equipment have been w eak as a result of the decline in offshore rig rates. Next
year, w e believe the Drilling group’s contribution to revenue and earnings grow th w ill be determined by the aftermarket segment in w hich the
company has very little forw ard visibility. Moreover, CAM has onshore U.S. exposure through its surface and distributor valves segments. Should
oil prices w eaken enough to push U.S. onshore E&P spending materially low er next year, our current 2015 earnings estimate w ould likely prove to
be too high.
FTI FTI currently trades at approximately 20x our 2014 EPS and 11x our 2014 EBITDA estimates. Our 12-month
price target of $70 reflects a multiple of 16.4x our 2015 EPS and 9.5x our 2015 EBITDA estimates.
In addition to oil-price related macro risks, w e believe FTI has a couple of company specif ic risks, including: 1) the timing of the delivery of its
intervention stacks next year (w hich w ould impact the timing of incremental subsea services revenues and earnings); and 2) the risk that frac
company’s scale back meaningfully on capex next year, adversely impacting FTI’s f luid-end orders, revenues, and earnings.
NOV NOV currently trades at approximately 12x our 2014 EPS estimate and 7x our 2014 EBITDA estimate. Our 12-
month price target of $90 reflects a multiple of 11.6x our 2015 EPS and 6.3x our 2015 EBITDA estimates.
Maintaining EPS of $6+ over the next tw o years requires onshore equipment orders to remain strong through 1H15, visibility of w hich w eakens as
oil prices retrench to the $70/bbl level.
TS TS currently trades at approximately 15x our 2014 EPS and 8x our 2014 EBITDA estimates. Our 12-month
price target of $50 is based on 11.3x our 2015 EPS and 6.6x our 2015 EBITDA estimates.
In addition to the risk to the U.S. rig count brought on by the recent correction in oil prices, w e believe the biggest risk to TS is margin associated
w ith shifting product mix. For instance, the absence of premium shipments to Saudi Arabia in 3Q14 are expected to contribute to a 100bp
contraction in EBITDA margin. Should premium volumes not recover in 4Q and 2015 in other regions, providing better balance to TS's mix, margins
could remain under pressure as volumes and revenues from commodity products (e.g., U.S. w elded OCTG) drive grow th.
Oilfield Services, Offshore Contract Drillers & Capital Equipment PAGE 37
OFS Valuations & Risks
Source: Thomson Reuters, Company Reports, Guggenheim Securities, LLC
Ticker Valuation Risks
CJES CJES currently trades at approximately 6x our 2014 EBITDA and 6x our 2014 OCFPS estimates. Our 12-
month price target of $32 is based on 6.5x our 2015 EBITDA and 6.5x our 2015 OCFPS estimates.
In our view , risk to our estimates stems from C&J’s ability to execute on the cost synergies it expects to realize from the merger; should integration
issues cause the transition to take longer than w e expect, there could be dow nside risk to our estimates. Conversely, should sustained higher oil
prices result in higher E&P spending levels than w e now expect, our estimates could prove too low .
CLB We arrive at our price target of $170/sh by calibrating against our P/E valuation framew ork and our
discounted cash f low valuation methodology. Future estimated earnings grow th discounted by our cost of
capital implies a valuation range betw een a 28.4x multiple on 2014 EPS and a 26.0x multiple on our 2015 EPS
estimate. Our DCF valuation implies a value of $170/sh, given strong grow th over the explicit forecast,
reinvestment of capital, and a normalization of returns w ithout economic rents. Also, yield-based metrics
support our $170 target.
Since CLB’s largest customers conduct roughly 75% of their reservoir testing in-house, there is a risk that they w ill look to fully integrate their
reservoir diagnostics internally. If the major integrated oil companies w ere to bring their testing in-house, roughly 30% of CLB’s revenues may prove
at risk. Secondly, increased perforation product competition from the larger pressure pumping players, like HAL, BHI, and SLB, w ould challenge
economics for CLB. In addition, if discovery of reserves in less challenging basins shifts the sources of production, the need for more data,
diagnostic tests, and equipment may decline w hich w ould adversely impact CLB’s earnings. Finally, if macro factors reduce commodity demand,
resulting in a collapse of oil and natural gas prices, numerous f ields may prove uneconomic, leading to reduced upstream spending to the detriment
of CLB economics. If macro factors turn out stronger than our expectations, thus increasing commodity demand, operator spending may provide
upside to CLB earnings.
CRR We arrive at our price target of $55 per share by triangulating betw een our P/E valuation framew ork, yield-
based metrics, and our discounted cash f low valuation methodology. In our view , yield metrics may offer
support but investor focus on grow th and operating leverage w ill continue to drive shares through traditional
earnings and cash f low metrics. Future estimated earnings grow th discounted by our cost of capital implies
a valuation range betw een an 16.3x multiple on our 2014 EPS and a 17.6x multiple on our 2015 EPS estimate.
Our DCF valuation implies a value of $55 per share, given grow th expectations over the explicit forecast,
reinvestment of capital, and a normalization of returns. Given management’s desire to maintain grow th of a
sustainable dividend, potential upside may lie in yield-based metrics, w hich may magnify the benefit of
outsized returns, free cash f low grow th, and the emergence and communication of a fuller payout strategy.
Market Oversupply from Low er or Higher Quality Entrants. In our view , the threat of higher marginal cost Chinese supply likely caps the excess
returns that may be seen in the North American proppant business. The threat of heightened pricing volatility from poorly managed inventories,
given the presence of distributors, likely increases the amplitude of economics across the business cycle. Superior Product Takes Market Share.
CRR appears to be the innovator in the industry, especially w ith the upcoming introduction of proppant for deepw ater use. If a new or existing
player w ere to create a better product alternative, CRR’s economics may prove at risk. Service Intensity Declines Across Basins. Grow th in
reservoir complexity, unconventional plays, and deepw ater activity continue to drive service intensity. If discovery of reserves in less challenging
basins shifts the sources of production, the need for more and higher quality proppant may w ane, adversely affecting CRR’s economics. Capital
Budgeting. CRR may overbuild capacity or add lines w ithin plants too quickly, expanding f ixed overhead to the detriment of returns. Since it costs
$70-75M to add a production line w ithin a nine-month timeline, CRR might f ind it easy to create a hiccup if it does not have clarity on the means of
how to sell out the new line upon start of additional operations. Macroeconomic Risks and Commodity Price Decline. Oil prices have recently
declined. If oil prices declined too far, numerous f ields may prove uneconomic, leading to reduced upstream spending to the detriment of CRR
economics.
Macroeconomic and Commodity Price Strength. If macro factors turn out stronger than our expectations, thus increasing commodity demand,
operator spending may provide upside to CRR earnings. Positive Investor Sentiment and Short Covering. If investors become more optimistic on
North American oil & gas activity in 2015, CRR’s stock could rise. In the near term, short covering may keep upw ard pressure on shares.
FI FI currently trades at approximately 16x our 2014 EPS and 5x our 2014 EBITDA estimates. Our price target of
$27 is based on 20x our 2015 EPS and 11x our 2015 EBITDA estimates.
Given that FI generates an estimated 72% of its revenue offshore—the majority of w hich comes from DW and UDW projects that have a higher
degree of complexity and are subject to delays related to engineering and project management constraints at the operator level, grow th beyond
2015 may not accelerate as w e currently expect. In addition, should the changes mgmt has made over the last several quarters require a longer
transition period to produce results than w e now expect, there may be dow nside risk to our estimates.
OIS OIS currently trades at approximately 14x our 2014 EPS and 6x our 2014 EBITDA estimates. Our price target
of $60 is based on 13.3x our 2015 EPS and 6.6x our 2015 EBITDA estimates.
Should oil prices drop below $80/bbl for a quarter or more, w e believe OIS's Wellsite Services—both completion and drilling segments—w ould
experience a decline in revenues and earnings. Conversely, the stock could move higher on M&A speculation, as OIS is often talked about as a
takeover candidate due to the strength of its franchises and management team.
SPN We arrive at our price target of $26 per share by calibrating betw een our P/E valuation framew ork and our
discounted cash f low valuation methodology. Future estimated earnings grow th discounted by our cost of
capital implies a valuation range betw een a 14.5x multiple on our 2014 EPS estimate and a 11x multiple on our
2015 EPS estimate. Our DCF valuation implies a value of $25/sh, given strong grow th over the explicit
forecast, reinvestment of capital, and a normalization of returns.
Undisciplined Grow th in International Markets. Given SPN’s international grow th ambitions, if it w ere to take an undisciplined approach, adding large
f ixed costs ahead of potentially risky revenue streams, SPN profitability may suffer. Failure to properly leverage capital expenditure may adversely
impact returns and economics. Lack of Execution Removes Competitive Advantage from Completions Business. Many of SPN’s larger competitors in
the pressure pumping business either bundle services, gain share w ith scale, or offer more value added services (IP) in order to maintain their
market share lead. While raw horsepow er continues to commoditize in the face of over-supply, SPN w ill need to maintain crew s and service
reliability in order to differentiate its offering. Macroeconomic Risks and Commodity Price Decline. Oil prices have recently declined. If oil prices
declined too far, numerous f ields may prove uneconomic, leading to reduced upstream spending to the detriment of SPN economics.
North American Market Strength. If the North American services market reaches a positive inflection point in the near/medium term, SPN w ould likely
benefit given its high leverage to the region.
SLCA We arrive at our price target of $70 per share by triangulating betw een our P/E valuation framew ork, yield-
based metrics, and our discounted cash f low valuation methodology. In our view , yield metrics may offer
support, but investor focus on grow th and operating leverage w ill continue to drive shares through
traditional earnings and cash f low metrics. Future estimated earnings grow th discounted by our cost of
capital implies a valuation range betw een a 24.3x multiple on our 2014 EPS estimate and a 21.1x multiple on
our 2015 EPS estimate. Our DCF valuation implies a value of $70 per share, given grow th expectations over
the explicit forecast, reinvestment of capital, and a normalization of returns. Given the f irm’s ability to convert
to an MLP structure, potential upside may lie in yieldbased metrics, w hich may magnify the benefit of
outsized returns, free cash f low grow th, and a fuller payout strategy.
Risks to our investment thesis include a shift in the market tow ards frac sand alternatives such as ceramic proppants; increased regulation
surrounding either sand mining activities or hydraulic fracturing; SLCA's customer concentration, as SLCA's top ten customers represented 52% of
its sales revenue during 2013; a logistical disruption or cost increases pertaining to transportation and handling as transportation costs represent a
signif icant portion of the delivered cost of sand; plant dow ntime, namely at one of the f irm's major plants; and, an economic/cyclical dow nturn that
reduces commodity demand and prices. Economic cycles impact commodity prices, w hich in turn impact fracking activity and sand demand.
TESO TESO currently trades at approximately 18x our 2014 EPS and 6x our 2014 EBITDA estimates. Our price
target of $23 is based on 11.3x our 2015 EPS and 4.4x our 2015 EBITDA estimates.
Last year, TESO generated roughly $100mm in revenue from equipment sales and services in Russia; how ever, this year, Russia as an end market
should be closer to $60mm. Although the market has proven to be very lumpy in the $60-100mm range over the last several years, w e believe the
U.S. and E.U. sanctions have started to have an impact on the outlook—both in terms of TESO’s w illingness to take the credit risk associated w ith
Russian sales, as w ell as the actual capex budgets of TESO’s Russian customers. Consequently, w e w ould expect Russian revenue next year to
drop to +/-$25mm, w hich TESO has indicated to be its recurrent services revenue. We also believe that the risk to this revenue—along w ith the
sentiment surrounding TESO’s historical exposure to Russia—could w eigh on multiples as w ell.
Oilfield Services, Offshore Contract Drillers & Capital Equipment PAGE 38
OFS Valuations & Risks
Source: Thomson Reuters, Company Reports, Guggenheim Securities, LLC
Ticker Valuation Risks
AKSO We arrive at our price target of kr75/sh by calibrating against our P/E valuation framew ork and our
discounted cash flow valuation methodology. Future estimated earnings grow th discounted by our cost of
capital implies a valuation range betw een a 17.8x multiple on our 2014 EPS estimate and a 14x multiple on our
2015 EPS estimate. Our DCF valuation implies a value of kr125/sh, given strong grow th over the explicit
forecast, reinvestment of capital, and a normalization of returns w ithout economic rents.
Business Model Risk - The transition to a matrix business model that crosses regional management and product management in order to create a
single point of contact w ith customers poses a risk to existing client relationships that may threaten future orders. At the same time, the change in
management structure may also lead to supply chain and other execution issues. There is a risk that AKSO may choose to grow revenues by
underbidding the competition on price. Resultant low er margin business may challenge the company’s margin expansion goals.
DRC DRC currently trades at approximately 31x our 2014 EPS estimates, and 16x our 2014 EBITDA estimates;
after the announcement of the acquisition by SIE, w e expect the deal to be completed and therefore have
based our target price on the agreed upon value of $83/sh, w hich implies target multiples of 25.5x our 2015
EPS and 14.0x our 2015 EBITDA estimates.
As w ith any acquisition, there is alw ays risk that the deal does not go through, in w hich case there may be dow nside risk to our estimates. In
addition, there is risk that a third-party intervenes w ith a higher offer, in w hich case our expectations may prove too low . How ever, as w e have
stated previously, w e believe SIE presents the best industrial f it for DRC, and consequently believe that the stock w ill trade in a relatively tight range
around $83 until the deal is completed in 2Q15.
DRQ We arrive at our price target of $100/sh by calibrating against our P/E valuation framew ork and our
discounted cash flow valuation methodology. Future estimated earnings grow th discounted by our cost of
capital implies a valuation range betw een a 19.9x multiple on our 2014 EPS estimate and a 18.2x multiple on
our 2015 EPS estimate. Our DCF valuation implies a value of $100/sh, given strong grow th over the explicit
forecast, reinvestment of capital, and a normalization of returns w ithout economic rents.
Not Hedge Its Raw Material Inputs. Given that Dril-Quip does not hedge its steel or other inputs, the risk remains that rising input costs may erode
margins on its f ixed price equipment. Historically, management has successfully aligned costs and revenues through thoughtful coordination of
tender pricing and supply chain management. Product Adoption. Management is focused on its core competency in w ellheads and specialty
connectors, but they have allocated capital and budgeted manufacturing capacity for grow th in liner hangers, manifolds, subsea trees and control
systems. Despite our view that the company w ill utilize its current relationships to increase its presence in these products in the improving market,
there is a risk that a failure to gain traction w ith customers may hamper capacity utilization and performance. Macroeconomic Risks and Commodity
Price Decline. Oil prices have recently declined. If oil prices declined too far, numerous f ields may prove uneconomic, leading to reduced upstream
spending to the detriment of DRQ economics. Macroeconomic and Commodity Price Strength. If macro factors turn out stronger than our
expectations, thus increasing commodity demand, operator spending may provide upside to DRQ earnings.
FET We arrive at our price target of $40 per share by calibrating betw een our P/E valuation framew ork and our
discounted cash flow valuation methodology. Future estimated earnings grow th discounted by our cost of
capital implies a valuation range betw een an 21.9x multiple on 2014 EPS and a 17.3x multiple on our 2015
EPS estimate. Our DCF valuation implies a value of $40/share, given strong grow th over the explicit forecast,
reinvestment of capital, and a normalization of returns.
We see the ability to f inance an acquisition strategy through debt or to maintain a valuation multiple that provides an accretive equity currency as
potential risks. The company may face competition from larger competitors if they enter FET's specif ic markets. If macro factors reduce commodity
demand, resulting in a collapse of oil and natural gas prices, reduced upstream spending w ould negatively impact the company's operations. In
terms of positive risks, if the North American services market reaches a positive inflectiion point, FET w ould likely benefit gtiven its high leverage to
the region.
OII We arrive at our price target of $80/sh by calibrating against our P/E valuation framew ork and our discounted
cash flow valuation methodology. Future estimated earnings grow th discounted by our cost of capital implies
a valuation range betw een a 20.1x multiple on our 2014 EPS estimate and a 17.7x multiple on our 2015 EPS
estimate. Our DCF valuation implies a value of $80/sh, given strong grow th over the explicit forecast,
reinvestment of capital, and a normalization of returns w ithout economic rents.
Macroeconomic Risks and Commodity Price Decline. We assume that the ROV business grow s w ith the expansion of the offshore rigs f leet and the
acceleration of offshore drilling activity. That said, oil prices have recently declined w hich may cause operators to reevaluate or delay certain
projects in the nearerterm. If oil prices declined too far, numerous f ields may prove uneconomic, leading to reduced upstream spending to the
detriment of OII economics. Contract Rolls. A signif icant portion of OII’s ROVs rolling off contract in 2015 do not yet have new contracts negotiated.
If low er-spec drilling rig attrition occurs during 2015 w e could see a decrease in demand for OII’s yet-to-be contracted ROVs. Strong Offshore Rig
Fundamentals. Persistently high dayrates and favorable supply/demand dynamics in the offshore rig market may benefit earnings.
Oilfield Services, Offshore Contract Drillers & Capital Equipment PAGE 39
OFS Valuations & Risks
Source: Thomson Reuters, Company Reports, Guggenheim Securities, LLC
Ticker Valuation Risks
ATW We arrive at a price target of $55/sh. Our methodology w eighs our NAV - Break-Up, or liquidation value of
the company, and our NAV - Reinvestment Value, w hich discounts the value of assumed future investment
against our view of the company’s capital budgeting strategy and our future forecast of the offshore rig
market across asset classes.
Risks include construction (4 new builds), BOP maintenance dow ntime & dayrate exposure. Rig construction programs run the risk of costs and
delivery overruns that may impact earnings. Operational execution risk leaves the chance for higher maintenance costs and dow ntime that may
impact earnings. In a higher scrutiny, post-Macondo w orld, the risk of higher maintenance is prevalent. Economic cycles impact commodity prices,
w hich in turn impact drilling activity and rig demand. Thus, an economic dow nturn may negatively impact earnings pow er.
DO We arrive at a price target of $50/sh. Our methodology triangulates betw een NAV - Break-Up, NAV -
Reinvestment, and yield based valuation metrics. While NAV provides baseline support, w e derive our price
target against yield- based valuation metrics, w here w e probability w eight the timing and magnitude of future
dividends in relation to the current capital market for yield entities.
Should midw ater dayrates exceed expectations DO could outperform, dow nside risks include construction and strategy (favoring dividends over
more aggressive reinvestment). Operational execution risk leaves the chance for higher maintenance costs and dow ntime that may impact
earnings. In a higher scrutiny, post-Macondo w orld, the risk of higher maintenance is prevalent. Economic cycles impact commodity prices, w hich
in turn impact drilling activity and rig demand. Thus, an economic dow nturn may negatively impact earnings pow er.
ESV We arrive at a price target of $44/sh. Our methodology triangulates betw een NAV - Break-Up, NAV -
Reinvestment, and yield based valuation metrics. While NAV provides baseline support, w e derive our price
target against yield- based valuation metrics, w here w e probability w eight the timing and magnitude of future
dividends in relation to the current capital market for yield entities.
Risks include construction and GOM exposure. Operational execution risk leaves the chance for higher maintenance costs and dow ntime that may
impact earnings. In a higher scrutiny, post-Macondo w orld, the risk of higher maintenance is prevalent. A potential overbuild w ithin any segment of
the rig market can depress dayrates and shorten contract durations to the detriment of earnings. Economic cycles impact commodity prices, w hich
in turn impact drilling activity and rig demand. Thus, an economic dow nturn may negatively impact earnings pow er.
HERO We arrive at a price target of $1.50/sh. Our methodology triangulates betw een NAV - Break-Up, NAV -
Reinvestment, and yield based valuation metrics. While NAV provides baseline support, w e derive our price
target against yield- based valuation metrics, w here w e probability w eight the timing and magnitude of future
dividends in relation to the current capital market for yield entities.
Risks include construction (1 new build) and GOM exposure. Operational execution risk leaves the chance for higher maintenance costs and
dow ntime that may impact earnings. In a higher scrutiny, post-Macondo w orld, the risk of higher maintenance is prevalent. A potential overbuild
w ithin any segment of the rig market can depress dayrates and shorten contract durations to the detriment of earnings. Economic cycles impact
commodity prices, w hich in turn impact drilling activity and rig demand. Thus, an economic dow nturn may negatively impact earnings pow er.
Persistently high dayrates and favorable supply/demand dynamics may benefit earnings.
NE We arrive at a price target of $30/sh. Our methodology triangulates betw een NAV - Break-Up, NAV -
Reinvestment, and yield based valuation metrics. While NAV provides baseline support, w e derive our price
target against yield- based valuation metrics, w here w e probability w eight the timing and magnitude of future
dividends in relation to the current capital market for yield entities.
Risks include construction (12 new builds), GOM and Mexico exposure, and RoF exposure. Given the volatility of contract dayrates and contract
terms, the company maintains a risk of low bids as the rig market improves as w ell as a false confidence in bargaining pow er as the market
declines. Rig construction programs run the risk of costs and delivery overruns that may impact earnings. Operational execution risk leaves the
chance for higher maintenance costs and dow ntime that may impact earnings.
ORIG We arrive at a price target of $15/sh. Our methodology triangulates betw een NAV - Break-Up, NAV -
Reinvestment, and yield based valuation metrics. While NAV provides baseline support, w e derive our price
target against yield- based valuation metrics, w here w e probability w eight the timing and magnitude of future
dividends in relation to the current capital market for yield entities.
Risks include construction (4 new builds). Given the volatility of contract dayrates and contract terms, the company maintains a risk of low bids as
the rig market improves as w ell as a false confidence in bargaining pow er as the market declines. Rig construction programs run the risk of costs
and delivery overruns that may impact earnings. Operational execution risk leaves the chance for higher maintenance costs and dow ntime that may
impact earnings. ORIG's relationship w ith DRYS may leave it exposed to unpalatable agency risk and dry bulk shipping exposure.
PACD We arrive at a price target of $14/sh. Our methodology w eighs our NAV - Break-Up, or liquidation value of
the company, and our NAV - Reinvestment Value, w hich discounts the value of assumed future investment
against our view of the company’s capital budgeting strategy and our future forecast of the offshore rig
market across asset classes.
Risks include construction (4 new builds) and BOP maintenance dow ntime. Rig construction programs run the risk of costs and delivery overruns
that may impact earnings. Operational execution risk leaves the chance for higher maintenance costs and dow ntime that may impact earnings. In a
higher scrutiny, post-Macondo w orld, the risk of higher maintenance is prevalent. Economic cycles impact commodity prices, w hich in turn impact
drilling activity and rig demand. Thus, an economic dow nturn may negatively impact earnings pow er.
RDC We arrive at a price target of $25/sh. Our methodology w eighs our NAV - Break-Up, or liquidation value of
the company, and our NAV - Reinvestment Value, w hich discounts the value of assumed future investment
against our view of the company’s capital budgeting strategy and our future forecast of the offshore rig
market across asset classes.
Risks include construction (4 new builds) and entry into new markets, w hich could potentially carry higher costs (UDW and SE Asia). Given the
volatility of contract dayrates and contract terms, the company maintains a risk of low bids as the rig market improves as w ell as a false confidence
in bargaining pow er as the market declines. Rig construction programs run the risk of costs and delivery overruns that may impact earnings. A
potential overbuild w ithin any segment of the rig market can depress dayrates and shorten contract durations to the detriment of earnings.
Persistently high dayrates and favorable supply/demand dynamics may benefit earnings.
RIG We arrive at a price target of $45/sh. Our methodology triangulates betw een NAV - Break-Up, NAV -
Reinvestment, and yield-based valuation metrics. While NAV provides baseline support, w e derive our price
target against yield-based valuation metrics, w here w e probability-w eight the timing and magnitude of future
dividends in relation to the current capital market for yield entities.
Macondo involvement remains a risk to the dow nside. Given the volatility of contract dayrates and contract terms, the company maintains a risk of
low bids as the rig market improves as w ell as a false confidence in bargaining pow er as the market declines. Operational execution risk leaves the
chance for higher maintenance costs and dow ntime that may impact earnings. In a higher scrutiny, post-Macondo w orld, the risk of higher
maintenance is prevalent. Economic cycles impact commodity prices, w hich in turn impact drilling activity and rig demand. Thus, an economic
dow nturn may negatively impact earnings pow er.
SDRL We arrive at a price target of $50/sh. Our methodology triangulates betw een NAV - Break-Up, NAV -
Reinvestment, and yield-based valuation metrics. While NAV provides baseline support, w e derive our price
target against yield-based valuation metrics, w here w e probability-w eight the timing and magnitude of future
dividends in relation to the current capital market for yield entities.
Risks include construction (16 rig new builds) and f inancial leverage, SDRL is the most levererd name in our group. Rig construction programs run
the risk of costs and delivery overruns that may impact earnings. Operational execution risk leaves the chance for higher maintenance costs and
dow ntime that may impact earnings. In a higher scrutiny, post-Macondo w orld, the risk of higher maintenance is prevalent. A potential overbuild
w ithin any segment of the rig market can depress dayrates and shorten contract durations to the detriment of earnings.
HP HP currently trades at approximately 6x our 2014 EBITDA and 8x our 2014 CFPS estimates. Our 12-month
price target of $110 is based on 16.0x our CY2015 EPS estimate and 6.5x our CY2015 EBITDA estimate.
Given our outlook that improved E&P liquidity due to higher Brent prices, the new condensate export relief valve, and continued capital markets
activity, should provide ample room for NA spending to continue to grow ~10% this year and next, w e expect utilization to remain ~90% and drive
earnings grow th of nearly 10% next year. How ever, should Brent begin to w eaken and saturation risk begin to w eigh on NA fundamentals going
into the end of 2014, our estimates may prove too high.
NBR NBR currently trades at approximately 5x our 2014 EBITDA and 3x our 2014 CFPS estimates. Our price target
of $32 is based on 14.0x our 2015 EPS estimate and 5.5x our 2015 EBITDA estimate.
The deal w ith CJES gives NBR the opportunity to refocus on its core drilling operations, thus allow ing NBR to benefit from the streamlining of its
portfolio as w ell as a “sum of the parts” valuation boost resulting from a real-time mark-to-market mechanism in CJES stock. How ever, should the
deal be delayed in getting approved, there may be dow nside risk to our estimates. On the other hand, should the deal be approved and the tw o
companies begin to realize synergies faster than w e now expect, w e submit our estimates may prove too conservative.
PTEN PTEN currently trades at approximately 4x our 2014 EBITDA and 4x our 2014 CFPS estimates. Our 12-month
price target of $40 is based on 5.5x our 2015 EBITDA and 5.5x our 2015 CFPS estimates.
We continue to believe that the market for AC-electric rigs remains under-supplied and that PTEN has emerged as a real leader in the AC market as
a result of the eff iciency of its APEX fleet and w orkforce. With our current outlook for improved E&P liquidity heading into 2015, w e expect this w ill
translate into continued market share grow th as heightened focus on eff iciency has led customers to prefer AC market leaders such as PTEN.
How ever, should NA fundamentals begin to break dow n due to Brent w eakness or unforeseen roadblocks in the condensate export relief valve,
commodity price w eakness may have a negative effect on E&P spending going into 2015, in w hich case our estimates may prove too high.
SSE SSE currently trades at approximately 5x our 2014 EBITDA and 2x our 2014 CFPS estimates. Our 12-month
price target of $33 is based on 5.5x our 2015 EBITDA and 3.5x our 2015 CFPS estimates.
Over the next 12 months, w e see tw o major risks, including 1) SSE's dependence on CHK and 2) operating leverage. With 80% of its revenue linked
to the capex budget of just one company, SSE has a level of customer dependence that is far greater than any of its peers. In addition, w hile w e've
identif ied that operating leverage is a source of potential upside for SSE, should PTL's margins begin to erode due to rising consumables costs,
labor, job ineff iciency, etc., the EPS leverage could cut the other w ay.
Oilfield Services, Offshore Contract Drillers & Capital Equipment PAGE 42
ANALYST CERTIFICATION
By issuing this research report, each Guggenheim Securities, LLC ("Guggenheim Securities") research analyst whose name appears in this report hereby certifies that (i) all of the views expressed in thisreport accurately reflect the research analyst's personal views about any and all of the subject securities or issuers discussed herein and (ii) no part of the research analyst's compensation was, is, or will bedirectly or indirectly related to the specific recommendations or views expressed by the research analyst.
IMPORTANT DISCLOSURESThe research analyst(s) and research associate(s) have received compensation based upon various factors, including quality of research, investor client feedback, and Guggenheim Securities, LLC's overallrevenues, which includes investment banking revenues.
Guggenheim Securities, LLC or its affiliates expect(s) to receive or intend(s) to seek compensation for investment banking services from Atwood Oceanics, Inc., Diamond Offshore Drilling Inc., Ensco plc,Hercules Offshore, Inc., Noble Corp., Ocean Rig UDW Inc., Rowan Companies Inc., Seadrill Ltd., Transocean Ltd. and Pacific Drilling S.A. in the next 3 months.
Please refer to this website for company-specific disclosures referenced in this report: https://guggenheimsecurities.bluematrix.com/sellside/Disclosures.action. Disclosure information is also available fromCompliance, 330 Madison Avenue, New York, NY 10017.
RATING DEFINITIONSBUY (B) - Describes stocks that we expect to provide a total return (price appreciation plus yield) of 15% or more within a 12-month period.NEUTRAL (N) - Describes stocks that we expect to provide a total return (price appreciation plus yield) of plus 15% or minus 15% within a 12-month period.SELL (S) - Describes stocks that we expect to provide a total negative return (price appreciation plus yield) of 15% or more within a 12-month period.NR - The investment rating and price target have been temporarily suspended. Such suspensions are in compliance with applicable regulations and/or Guggenheim Securities, LLC policies.CS - Coverage Suspended. Guggenheim Securities, LLC has suspended coverage of this company.NC - Not covered. Guggenheim Securities, LLC does not cover this company.
Restricted - Describes issuers where, in conjunction with Guggenheim Securities, LLC engagement in certain transactions, company policy or applicable securities regulations prohibit certain types ofcommunications, including investment recommendations.
Monitor - Describes stocks whose company fundamentals and financials are being monitored, and for which no financial projections or opinions on the investment merits of the company are provided.
Guggenheim Securities, LLC methodology for assigning ratings may include the following: market capitalization, maturity, growth/value, volatility and expected total return over the next 12 months. The pricetargets are based on several methodologies, which may include, but are not restricted to, analyses of market risk, growth rate, revenue stream, discounted cash flow (DCF), EBITDA, EPS, cash flow (CF),free cash flow (FCF), EV/EBITDA, P/E, PE/growth, P/CF, P/FCF, premium (discount)/average group EV/EBITDA, premium (discount)/average group P/E, sum of the parts, net asset value, dividend returns,and return on equity (ROE) over the next 12 months.
RATINGS DISTRIBUTIONS FOR GUGGENHEIM SECURITIES:IB Serv./ Past 12Mos.
Rating Category Count Percent Count Percent
Buy 108 59.67% 19 17.59%
Neutral 73 40.33% 4 5.48%
Sell 0 0.00% 0 0.00%
OTHER DISCLOSURES
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