Offshore Drillers Begin To Emerge From Stormy Seas – Seeking Alpha

After almost three years of flagging demand, offshore drillers are seeing the first signs of a turnaround. Down over 40% from its cyclical peak, global offshore rig count appears near bottom. And bidding activity for future work is accelerating as both drillers and operators recalibrate to make projects work at lower commodity prices.

Not all of the emerging work will be high day-rate in nature. In the short term, well interventions, sidetracks, and plug and abandonments will represent more demand than usual. Longer term, more lucrative term drilling will be driven by still-materializing cost reductions, including savings from standardization and smarter preventative maintenance programs.

Even a modest upturn will be welcome. After OPEC's decision to open the spigots in 2014, drillers scrambled to adjust to the abrupt change in market conditions. News of reorganizations, asset sales, fleet reductions, rig-delivery delays, and recapitalizations came to dominate the sector. On average, share prices of the largest providers fell a staggering 79% over the period.

The segment still faces headwinds. Day rates will remain under pressure at least through 2017. And offshore discoveries - the lifeblood of future drilling - are down almost 60% from 2014 levels. Offshore reserve additions totaled only 2.4 billion barrels last year.

While these factors auger well for oil prices longer term, they suggest more tepid demand growth in the mean time. For projects that do materialize, new rigs coming out of shipyards will ensure competition remains stiff.

Still, some contractors will benefit more than others as offshore work increases. The following metrics and resulting scoreboard can help determine which are best positioned:

Stock-price Performance: The ability of a driller to operate effectively during times of change is important. Stock-price performance since Q2 2014 is a proxy for how companies handled the steep decline in oil prices.

Return on Assets: ROA measures the effectiveness of a company's management, strategy and operations. While ROA can vary based on how aggressively a driller retires or writes down assets, it's worth watching.

Debt-to-Equity Ratio: A high debt-to-equity (D/E) ratio limits flexibility. Moreover, management teams focused on servicing debt are less focused on other aspects of the business.

Backlog Ratio: This measures backlog relative to the book value of a driller's fixed assets (mostly rigs). A higher ratio connotes greater visibility to the business. The ratio is a financial proxy for customer preference and faith in a driller.

Customer Satisfaction: EnergyPoint Research's independent customer satisfaction scores can be strong indicators of future financial performance. The reasons are self-evident: customers contract with their preferred drillers more often, for longer periods and at higher rates.

Customer Satisfaction Trends: Market changes affect performance. This metric captures driller trends in customer satisfaction since oil prices began weakening in Q2 2014.

The scoreboard's "INDEX" column is the average of driller rankings across the six metrics. Customer satisfaction metrics receiving double weighting. The results suggest Ensco (NYSE:ESV) and Noble (NYSE:NE) are currently the best positioned for an upturn. Transocean (NYSE:RIG), Diamond Offshore (NYSE:DO), and Rowan (NYSE:RDC) follow.

Ensco and Noble outperform in customer satisfaction, while Transocean and Diamond benefit from strong backlogs. Leading ROA and stock-price performance, as well as balance-sheet strength, drive Rowan's standing.

Atwood Oceanic's (NYSE:ATW) scorecard is burdened by its customer satisfaction trend and lower ROA. However, the company retains low leverage and the resources to rebound. Seadrill's (NYSE:SDRL) metrics reflect a company in distress with rankings in the bottom half of each dimension.

So, why overweight customer satisfaction? Because when customer satisfaction moves in a particular direction, operational and financial performance tend to follow.

As a general rule, customer perception of a driller's job quality, performance and reliability, and service and professionalism go a long way toward predicting overall customer satisfaction. Although drillers as a group have done a relatively good job in these areas, there is room for improvement for individual drillers.

Below are the key customer satisfaction dimensions for offshore drillers and why they matter:

Job Quality: A measure of organizational and procedural effectiveness. Job quality influences overall satisfaction because is reflects whether contractors meet expectations.

Performance and Reliability: Performance and reliability measures the dependability of personnel and assets. Contractors that proactively address shortfalls enjoy greater customer loyalty.

Service and Professionalism: Highly rated contractors tend to be more selective in their hiring and have higher rates of employee retention. A drive to maintain long-term customer relationships is also pervasive in these companies.

Few can say what the future holds precisely for offshore drillers. However, with conditions improving, it's a good bet drillers mastering the things that matter to customers will see their opportunities grow and financial results outperform.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: My firm, EnergyPoint Research, does and/or seeks to provide for-fee data subscriptions to oil and gas industry participants, investors and other stakeholders, including companies covered in its posts, reports, articles and surveys.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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Offshore Drillers Begin To Emerge From Stormy Seas - Seeking Alpha