Search for a Hero in Offshore Drilling Can Start Right Here

Search for a Hero in Offshore Drilling Can Start Right Here

Investors eyeing Hercules Offshore (NASDAQ: HERO) to be one of their portfolio champions could very well be looking in the right direction. The recent divestment of its under performing domestic lifeboat and inland segments is but a preamble to the company's recent moves to turn itself into a more geographically diversified operation.

Specifically, Hercules is increasing its presence in the Middle East and West Africa where total offshore drilling expenditure in the 2012-2016 period is expected at $77.3 billion, a 22% increase from the previous five-year period. Pivotal to this thrust, the company recently acquired in full Discovery Offshore, a pure-play, ultra high-specification jackup drilling company.

Fleet further strengthened
Two Discovery rigs are due for delivery this year and will be Hercules' newest additions to its fleet of 40 jackup rigs and 24 liftboats. Early this year, the company also acquired a liftboat for $42 million from KS Energy and an offshore drilling rig for $55 million from KCA Deutag. These moves underscore the capability of Hercules to make strategic and high-return acquisitions. Significantly, the recent liftboat acquisition fortified the company's position as the largest liftboat provider in West Africa.

Hercules describes the Discovery jackups as world-class, higher specification rigs expected to deliver thirty-plus years of earning capacity. Designed for operating in harsh environments, the two Discovery jackup rigs operate in water depths of up to 400 ft. and are capable of drilling up to depths of 35,000 ft. The rigs are also constructed with high-pressure systems complying with the stringent specifications of Saudi Aramco, one of Hercules' major international customers.

Stepping on the gas at the gulf
Hercules' strong bid for a greater international presence is complemented by robust growth expected from its domestic offshore segment in the Gulf of Mexico where drilling has again intensified after the moratorium following the 2010 BP (NYSE: BP) oil spill. Notably, this oil major has remained one of the most active in the gulf, having successfully bid for 11 drilling blocks made available in late 2011.

BP and other oil majors like Chevron (NYSE: CVX), one of Hercules' customers, currently need to ramp up their production levels, which have been on a downtrend amid soft crude prices. For BP, a drop in U.S. output during its most recent quarter contributed to a 25% decline in net income. What could bring some relief for this oil producer is its Mars B project in the gulf, expected to start in 2014.

Pumped up Hercules rigs
The story is similar to Chevron's, whose year-over-year decline in output in the recent quarter was coupled with a hefty 26% drop in net income. Chevron certainly would need all the push on the gas pedal from the three rigs it has contracted with Hercules at the Gulf of Mexico.

All told, Hercules has 18 marketed rigs in the gulf, all of which are under contracts. The average utilization of these jackups has averaged approximately 90% since late 2011. Day rates have been rising and the company's current backlog is at a record level. Contract visibility extends well into 2014 for the majority of Hercules' domestic jackup fleet. The average term of recent contracts ranges from six months to more than a year, a substantial improvement from three months or less in previous periods.

Positive second quarter
The frenetic oil search and extraction in the Gulf bodes well for more contract extensions and added revenues for Hercules. Already, its domestic offshore revenue for the 2013 second quarter has risen by about 41% to $127 million from $90.1 million, mainly due to increased day rates for its rigs.

For the quarter, Hercules recorded $16.6 million net income from continuing operations on revenue of $211.5 million, compared with a $52.5 million loss on revenue of $154.5 million a year ago. Significantly, the company's EPS of $0.10 for the quarter was ahead of the $0.05 analysts' consensus estimate. For its trailing 12 months, the company came out with a 10.2% operating margin and has a forward P/E ratio of 9.

Concluding thoughts
Hercules is well positioned to capitalize on its second quarter gains and sustain these positive results for the long term. The tailwinds from its gulf operations, coupled with its broadening international platform and more focused business model, appear robust enough for this company to be a leading pick among oil and gas drilling players.

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