Shares of offshore oil services and drilling companies have been among the biggest beneficiaries of the rise in oil prices, but now they may be seriously overvalued, and thus in danger of major pullbacks. J. David Anderson, an analyst with Barclays, calls these stocks the "most overvalued group in our coverage universe," and estimates that they have significant downside risk from current prices, Barron's reports. As a result, he has placed underweight ratings on all five leading offshore drilling stocks: Diamond Offshore Drilling Inc. (DO), Ensco PLC (ESV), Noble Corp. PLC (NE), Rowan Companies PLC (RDC) and Transocean Ltd. (RIG).
Gushers For Investors
|S&P 500 Index (SPX)||15.2%|
Source: CNBC; YTD gains computed as of the close on August 14.
Anderson's pessimism about these offshore drilling stocks hinges on his observation that drillships and drilling submersibles, both often called "floaters," are in oversupply. Utilization rates for both categories of floaters have been trending downward since mid-2015, and now stand at roughly 60% and 40%, respectively, per IHS Markit. Despite the uptick in oil prices, this oversupply of drilling capacity has led to a downtrend in the day rates, or daily rental fees, for floaters. The day rates for both categories of floaters are now less than $150,000, also per IHS Market.
Meanwhile, the recent spurt in the prices of offshore drilling stocks implies a belief that day rates will exceed $400,000 by the middle of 2022, according to Anderson's analysis. This is roughly where day rates were in 2015, based on IHS Markit data. Anderson's "conservative" scenario calls for a day rate of $305,000 by the third quarter of 2021 and $405,000 by the fourth quarter of 2025. (For more, see also: Top 4 Alternative Energy Stocks.)
Downside Risk Per Barclays
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Sources: Barron's, CNBC; Implied declines are computed based on August 14 closing prices.
Victims of Success
Diamond and Transocean also may be victims of their own success in delivering greater efficiencies. Anderson indicates that these companies seem to be succeeding in drilling wells more quickly, which reduces the break-even times of the projects for which they are hired. However, they are not winning increased day rates for their efforts.
Diamond does not expect to earn higher day rates for its new drillships any earlier than 2020 or 2021, Anderson notes, and he quotes Noble as telling investors that "we haven't seen leading-edge day rates move in quite some time."
Transocean reports a growing contract backlog, now up to $11.7 billion in prospective future billings, equal to about four times current annual revenues. However, it acknowledges that the backlog "includes dayrate reductions on four of the company's newbuild drillships," per its most recent Quarterly Fleet Status Report.
While Barclays is negative on Ensco, Goldman Sachs is among the firms that have assigned it a buy rating. Among the positives being cited for the company is its acquisition of competitor Atwood Oceanics. Nonetheless, a majority of analysts covering the stock have issued hold or underperform ratings, per Yahoo Finance. (For more, see also: The 5 Best Energy Stocks for 2018.)