Offshore Drilling: Value and Yield

04/17/2014 9:00 am EST


Joon Choi

Senior Portfolio Manager, Research Analyst, Signalert Asset Management LLC

Overall stock valuations in the US continue to get rich and, as a result, it's hard to find stocks that are worth buying. However, I believe that offshore drilling companies offer some opportunity, says Joon Choi in Systems & Forecasts.

These companies contract their services for extracting offshore oil and gas for major oil companies. If the global economy is indeed improving and the demand for oil rises, major oil companies may have no choice but to increase the use of offshore drilling to meet the additional demand.

This will be great news for offshore drilling companies like SeaDrill Limited (SDRL) and investors will take notice once again. I particularly like SDRL because they have the lowest P/E ratio and highest yield.

I caution, however, that dividends are likely to get cut because the company’s future profit projection is lower than the previous year, which means the earnings will shrink as well (this will lead to higher P/E ratio).

This could result in a dividend cut, resulting in a dividend yield more in line with Ensco PLC (ESV), which yields 5.8%, and Transocean (RIG), which yields 5.4%.

The debt to equity ratio is higher for SDRL (56.8% versus 24.5% and 32.9%), which may be another reason why the P/E ratio is significantly lower than the other two stocks.

I like SeaDrill, even with a possible impending dividend cut, because I believe the stock is poised for a good rally (technically speaking) for three reasons: SDRL is near the bottom of the trading channel, the weekly MACD has turned up, and the RSI seems to be bottoming out.

Meanwhile, Ensco Plc and Transocean Limited also look attractive, but for slightly different reasons:

1. Dividend yields of 5.8% and 5.4%, respectively, are much higher than 1.85% for the S&P 500 Index (SPX).

2. The price to book ratio is 0.95 for Ensco and 0.89 for Transocean, which are both lower than the S&P 500 Index figure of 1.19.

Overall, I am having trouble finding stocks or sectors those are worthwhile for investing, due to the current high valuation of stocks. But offshore drilling companies seem attractive.

SeaDrill may have hit the intermediate bottom and rally for the next couple of months, based on technical analysis; as such, this position may be better suited for short-term investing.

Meanwhile, Ensco and Transocean are currently trading slightly below book value along with low P/E ratios. These two stocks seem to have a better fundamental outlook than SeaDrill and I like them for the long-term investment horizon.

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