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UBS Investment Research
Aban Offshore
Running a tight ship
„ Assume coverage with a Buy rating on an improving outlook
We assume coverage of Aban Offshore (Aban), with a positive view as we believe:
1) oil prices will remain high; 2) oil companies’ E&P capex will rise; and 3) oil
service companies’ margins will improve on higher demand for oil services at a
time when costs are not the primary concern of oil companies. We view any equity
offering to deleverage the company as a key catalyst for the stock.
„ A young premium fleet
Oil companies increasingly look for marginal oil in a rising oil price scenario. Even
in shallow water, we expect demand for higher specification rigs to continue to rise.
We believe Aban is well positioned to benefit from this trend, with 55% of its rigs
capable of reaching water depths of 350ft+ and the second-youngest jack-up fleet in
the world. There is an increasing preference for newer rigs—the global utilisation of
jack-ups built before 2000 is 70%—but 90% of post-2000 jack-ups are deployed.
„ We expect higher day rates for the next set of deep-driller contracts
By FY13, we expect older jack-ups to start being phased out and the rates cycle to
turn for rigs built post 2000. In FY13, contracts of seven Aban rigs will come up
for renewal, and we assume 45% higher rates when these are redeployed. Our
FY11/12/13E EPS is Rs98.39/94.46/159.06 (from Rs321.65/351.39/353.91).
„ Valuation: Buy rating (from Sell) and PT of Rs1,216 (previously Rs1,300)
The stock is attractive, in our view, as it is trading close to our estimate for Aban’s
replacement cost of Rs700/share. We derive our price target from a DCF-based
methodology and explicitly forecast long-term valuation drivers using UBS’s
VCAM tool. We assume a WACC of 12.02%. We believe Aban’s strategy is to
concentrate on revenue consolidation and strengthening its balance sheet.
However, jack-up rig oversupply could be a short-term overhang on the industry.
Investment Thesis
We assume coverage of Aban Offshore (Aban) with a Buy rating and a price
target of Rs1,216 on: 1) our expectation of continuing high oil prices; 2) the
higher capex outlook of global oil companies; and 3) increasing demand for oil
services at a time when costs are not the prime concern for oil companies, and
hence service companies should generate attractive margins. We believe
potential capital raising to deleverage is an important stock price catalyst.
We are positive on Aban’s business because: 1) the market is becoming
increasingly bifurcated and is turning favourable towards Aban’s asset mix; 2)
we expect contract renewals post FY13 to be at 45% higher rates; 3) Aban’s
fleet is shifting towards non-commoditised advanced rigs, which contribute
64% of the company’s revenue; and 4) it has a diversified customer mix with a
strong drilling services backlog of US$1.663bn. Aban has the second-youngest
fleet in the world with an average age of 12 years. This, combined with the fact
that 60% of its rigs can reach a water depth of 350 feet or more, means the
company is well positioned for the current jack-up demand/supply dynamics,
where demand for new jack-ups is disproportionately high. The average jackup utilisation is 76%, but 90% of the jack-ups built post 2000 are deployed. As
33 jack-ups are scheduled to come online by 2012 globally, we expect Aban’s
older fleet to be phased out over time. We expect the seven Aban rigs that
come up for contract renewal in FY13 to be deployed at 45% higher rates.
Aban benefits from its strategy of favouring long-term contracts and having
somewhat captive clients, such as ONGC and Iranian Offshore Oil Company
(IOOC). An average Aban jack-up is placed at a day rate of US$134,000/day
compared with the global average of US$73,000/day. This is due to 1) the
higher rates younger deep drillers can command, and 2) long-term contracts
that were entered into at the peak of the market.
We believe the stock is attractive at the current level—trading close to its
replacement cost estimate of Rs700/share. Aban’s key challenges are: 1) high
leverage (net debt-to-equity of 5.23x) with a bullet payment in 2012, and 2)
slowing demand for its older Aban Series rigs, which might need to be retired
sooner than expected.
Key catalysts
Higher oil prices—Drilling service companies in general are highly correlated
with oil prices. As oil prices rise, oilfield operators have an incentive to make
incremental investments until their marginal fields are profitable and hence
drilling activities increase. Unlike the 1990s, when oil prices were rangebound,
crude markets were very volatile in the last decade with a further disconnect
from demand supply ‘fundamentals’. Nonetheless, oil markets in 2010 evolved
broadly in line with expectations. We estimate the marginal cost of oil
production at approximately US$75 in West Africa and tar sands. A rising crude
price environment helps, as companies have more cash in hand to invest, also
UBS has increased its oil price forecast for 2011 and beyond. We expect an
increase in oil prices that improves the outlook for Aban’s rig services to act as a
stock price catalyst.
Increased visibility on higher capex by major oil companies—Aban’s
earnings depend on the company’s ability to minimise the number of offcontract days for its rigs and maximise the day rates it can charge. Its day rates
are mainly driven by the capex in the oil and gas sector. We believe the outlook
here is improving. The results of a survey of 31 UBS analysts across the globe
conducted by the UBS industrials team support this view. The analysts surveyed
cover more than 200 companies around the world with over US$300bn of
capital spending. 68% of the oil/gas/chemicals analysts responded that they
believe capex spending by companies under their coverage will increase.
Moreover, the oil & gas analysts that expect lower capex cover North American
gas-related companies; hence Aban’s clients are more skewed towards
increasing expectations of capex spend. We expect increased visibility by major
oil companies on higher capex to be another important share price catalyst
Large debt refinancing repayments—At the end of FY10, Aban had a high
net debt-to-equity ratio of 6.45x. We expect this to come down to 3.41x by
FY13, mainly through the utilisation of cash from operations for debt reduction.
Aban has already used the proceeds from its insurance claim related to the
sinking of Aban Pearl to reduce its debt. We expect the company to use
US$275-300m every year to service and pay down its debt. Aban is scheduled to
make total debt repayments of US$374m in FY12, besides servicing interest of
US$268m. We expect it to refinance about US$400m of debt in 2012 and move
to low-cost dollar-denominated debt. Further, we believe there is a high
probability the company will raise equity as a measure to deleverage in the
current favourable environment, given the high promoter holding of 53% and
low institutional holding (domestic + foreign institutional investors) of 9.65%.
We believe this is a potential trigger for stock performance.
Higher rates for newer rigs—We expect Aban’s young fleet (Deep Driller1–8)
to benefit from an increasingly bifurcated market. Operators are increasingly
demanding higher specifications for jack-ups, such as a rise in hookload (2m
pounds) and mud pump capabilities required for high pressure high temperature
(HPHT) drilling. There is notable demand for these rigs in Saudi Arabia, the
North Sea (Aban’s rigs are not designed to work in the harsh conditions of the
North Sea), and South East Asia. This trend benefits Aban as it has acquired its
deep drillers evenly over the past four years. It also means that the company’s
older Aban Series rigs may need to be retired or moved for use as offshore
accommodation over time.
Aban deployed most of its existing rigs when oil was below our target of
US$85/bbl and when rig rates were low. We expect rig deployment post FY13 at
45% higher rates. We believe the jack-up market will become increasingly
bifurcated, with some jack-ups unlikely to return to work and expect higher day
rate increases for high-specification jack-ups in FY12. We think such higher day
rates will be a share price catalyst.
New contract wins; long-term contracts—Aban’s success in signing contracts
with PetroBras, Shell Brunei and Gujarat State Petroleum Corporation (GSPC)
in the past few months indicates the robust demand for its younger fleet. It also
suggests the sinking of Aban Pearl has not put the company out of favour with
customers. Three of the company’s seven older rigs will come up for contract
renewal in the next quarter besides the drillship Deep Venture which Aban is
currently marketing and one rig with a contract ending May 2011. An average
jack-up earns a day rate of about US$73,000, while an average Aban jack-up is
placed at US$134,000/day as 1) younger deep drillers command a higher rate,
and 2) Aban has long-term contracts for its jack-ups that were entered into at the
peak of the market. This average may decrease as the three jack-ups come up for
contract renewal by the end of next quarter, but it suggests having long-term
contracts gives Aban more earnings visibility. One of the jack-ups, Aban II, is
the MAT supported slot type of rig. We expect ONGC to renew its contract for
the rig as such rigs are designed for the softer sea bed where the spud cans of the
independent leg cantilevers can excessively penetrate the soft sea bed. We
believe announcements on contract wins/renewals relating to the three jack-ups
will serve as stock price catalysts.
Risks
Refinancing risk—Since the acquisition of Sinvest, a Norwegian rig operator,
in 2007 Aban has become highly levered. Drilling rigs are stable annuityproducing assets, and given the comfort of minimal counterparty risk from large
oil companies, LTV ratios of 70% are common in the industry. However, Aban
overleveraged for the Sinvest acquisition and now the industry cycle has turned,
we believe the continuous need for the subsidiaries to refinance leaves it with
little financial flexibility. Refinancing debt due for repayment in FY12 will
become critical for the company, in our view.
Ageing rigs—Nine of the company’s rigs are more than 30 years old and have
been refurbished within the past 10 years. They contribute about 35% of revenue
currently. Worldwide utilisation of such older rigs is in the low 70s percent
range. Further, 33 new rigs are coming into service in 2010-12, and the
deliveries of 17 of these have been announced for 2011. We therefore expect
supply to more than match the increased demand for jack-ups. As this happens,
older rigs may need to be retired or used for accommodation purposes. For
instance, Ensco recently sold Ensco 60 (300ft –IC, 1981) for US$27m. This will
be converted to a mobile production unit.
Later-than-expected jack-up rig market recovery—Our thesis of the cycle
turning in FY13 would hold if rigs older than 30 years start retiring as 33 jackup rigs come into service by 2012 globally. Therefore, the market could remain
depressed much longer than we expect. However, in that scenario, Aban’s older
Aban Series rigs, which we assume will start retiring from 40 years of age, will
still contribute to earnings and make up for the low rates.
Valuation and basis for our price target
We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers with UBS’s VCAM tool. We incorporate
rig-by-rig projections to model Aban and arrive at our price target of Rs1,216.
The current share price implies an EBITDA margin of 35% for Aban on a
consolidated basis—which is low, given that historically Aban’s EBITDA has
ranged from 50% to 60%. We assume 1) 12.02% WACC, and 2) that half of the
older refurbished rigs will retire after the visible horizon of six years.
Aban looks attractive on a multiple basis
The company is trading at 1.4x FY11E P/BV, which is attractive on a historical
and on a peer comparison basis.
UBS versus consensus
We believe our FY13 revenue estimate is higher than consensus as we factor in
an improving rig environment starting FY13 and expect contract renewals then
at a higher price than previously. Our lower EBITDA numbers for FY11 and
FY12 could be due to our lower operating-margin forecasts. We believe this is
true for FY13 also, but we think that because of our higher revenue estimates the
absolute EBITDA number is higher than consensus. We believe as Aban rigs
continue to be deployed worldwide, some of the gap between its costs and those
of competitors should narrow as its operations conform to international
standards.
The difference between our earnings estimates and consensus could be due to
differing assumptions for depreciation. Also, we could be assuming a higher
interest expense, given our belief that the company will have to pay a higher
interest rate as it renegotiates its debt.
Sensitivity analysis
Sensitivity to day rates
Aban’s rigs are contracted out on a day-rate basis. The industry is highly
cyclical and day rates can swing by 100% from good times to bad. Day rates can
differ by two to three times between various specifications of jack-ups and
drillships, especially in an oversupplied market, as is the current case.
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