This Drilling Contractor Should Have a Great Decade

This Drilling Contractor Should Have a Great Decade

It's been a while since "Drill, baby, drill" was one of the dominant topics of discussion in American politics, but the U.S. is still quietly trending toward energy independence. While we won't break our dependence on foreign oil anytime in the very near future, oil production is picking up in North America and looks like it will continue to do so for the next several years. One sub-sector that stands to benefit greatly is the oil rig companies, such as Transocean , which tend to have an excellent backlog of business, sound fundamentals, and relatively consistent income. Let's take a look at Transocean and a few others that may benefit from this trend as well.

How Transocean and other offshore drilling contractors make their money
Transocean and similar companies essentially make their money by building drilling rigs for use in specific environments (various water depths), then leasing them to oil companies for extraction. For example, the infamous Deepwater Horizon disaster was a Transocean rig that was leased to BP.

Transocean specializes in the deepwater category, but has rigs in all four major classifications. Of the company's 82 rigs, 27 are designed for ultra-deepwater (depths of over 7,500 feet), 14 for deepwater (4,500-7,500 feet), 25 for midwater (400-4,500 feet), and nine jackup rigs, which are used for depths of under 400 feet and are supported on the ocean floor, as opposed to floating like the other three types of rigs.

Transocean's future growth (and risks)
Aside from a nice backlog of business already on the books, there are several other reasons to like Transocean's future prospects. There is some continued legal risk related to the Deepwater Horizon incident, but I feel that the majority of the potential damage is in the past, especially since the company settled with the DOJ in January. There are a few civil claims pending in the Eastern Louisiana U.S. District Court which are worth keeping an eye on, but aren't a huge cause for concern at this time. The first phase to determine negligence is over, and the second phase of the civil trials starts in September and will focus on how much oil spilled and which of the companies involved are responsible for it.

The company has and intends to maintain a leading position in the ultra-deepwater space, which currently makes up about 70% of the company's backlog. The 27 ultra-deepwater rigs referenced above actually make up more than one-fifth of all ultra-deepwater floating rigs worldwide. Ultra-deepwater rigs also bring with them a higher profit margin than other types and have average daily lease rates of about half a million dollars. With demand increasing rapidly, industry experts are projecting the worldwide fleet of deepwater rigs to nearly double over the next decade.

Other beneficiaries
The drilling contractors themselves are not the only ones who stand to benefit from this trend of course. Refining and marketing companies that have most of their operations in North America, such as Phillips 66 also have great exposure to increased domestic production. With about 82% of their production capacity inside of the U.S., Phillips is in an excellent position to benefit from the cost-efficiencies that come with having your "suppliers" very close to you.

Other companies like Oceaneering , that provide engineering and maintenance services to deepwater rigs should have a steadily increasing stream of income as more new rigs are built and the current fleet ages and needs repairs. The company has a unique product mix that includes remotely operated vehicles that can get to parts of a rig that are very deep, customized subsea hardware, and engineering and project management services.

Why it's a good value
One of the main reasons that Transocean is very appealing right now is its price. The current share price is just over its 52-week low, and I don't think there is much more room to fall. Shares trade at just 11 times this year's expected earnings of $4.07, which are expected to grow significantly in 2014 to $5.47. The company has a $27.3 billion backlog of business, and its rigs are already 73% booked for 2014. All of this combined with a very healthy dividend yield of just under 5% makes Transocean a very attractive play on increased future drilling activity in and around North America.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Oceaneering International. The Motley Fool owns shares of Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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