Description
Northern Ocean, which owns 2 ultra-deepwater, harsh environment semi-submersible rigs (Bollsta and Mira), will exhibit a spectacular turnaround in free-cash flow, as it goes from zero fleet utilization in Q3 2022 to 100% in Q3 2023. By Q3 2023 its annualized FCF should be around 106 USDm or a FCF yield of 52%!
The current share price of around 11NOK is substantially below the June 2022 level of 16 NOK, as NOL tapped the market in August and December with two cap hikes, (NOK 12.6 and NOK 9.5 respectively, current EV of around 600 USDm is nevertheless slightly below the June 2022 level) increasing the float by 74m shares to 182m. Thereby NOL is now sufficiently funded to mobilize its two rigs.
Since mid December2022 the 12m+ 6m options of Bollsta with Shell has commenced and in mid Q2 2023 Mira is expected to commence its 300d fix +180d+90d optional for Total in West Africa (firm USD 135m excluding bonus, options and de-mobilization). Thus Q1 2023 will show a 50% fleet utilization and Q3 will be another step change will 100% fleet utilization.
While by Q3 the cash flow strength should become apparent, the offshore cycle is likely to continue, as declining shale productivity removes the force that killed the offshore market in 2014.
Spare capacity in the oil industry has declined and offshore is very profitable at current prices.
On the other hand, the supply of semis is declining.
Leading to increasing dayrates
While Northern Ocean’s current dayrates already lead to strong free cash flow generation, we have still substantial upside potential to reach the cycle peak.
At the peak of the last cycle, when the construction of Bollsta and Mira was ordered, their initial long-term contracts were for dayrates of 560k USD and 640k USD respectively.
https://gcaptain.com/dolphin-drilling-gains-long-term/
https://gcaptain.com/husky-awards-5-year-contract-seadrill/
Thus, the peak cycle cash flow potential should move into the focus in the next two years as well. The last cycle has demonstrated the risks of awarding long-term drilling contracts to a newly built rigs. Indeed, both Mira and Bollsta were ordered in 2012 for delivery in 2015, however both were not finished in time to commence their drilling contracts resulting in costly lawsuits with the shipyards and cancelled drilling contracts. The rigs were finally delivered in 2018 and 2019 respectively.
https://maritime-executive.com/article/fred-olsen-cancels-hhi-contract
Due to high uncertainties regarding construction time, risk of cost overruns and decent order situation of shipyards, there is little risk of rising supply due to newbuilds. Should the fleet utilization of the industry continue to rise as expected, the replacement costs for the assets, i.e. around USD 750m per rig should increasingly come into focus. Bear in mind this are basically 2015 dollars, as there has been no newbuilt activity, and these numbers therefore most likely understate the replacement costs.
https://gcaptain.com/diamond-offshore-orders-755-million/
Valuation
Based on the current contracts and market we would value the asset at 5x annualized Q3 2023 FCF or just over 500 USDm equity value (ca USD 2.36 USD or NOK23.3 per share), i.e. roughly 100% upside in the next 12 months. Should we get more indications for the dayrates approaching the prior cycle highs, we would expect valuation to approach the replacement value of the rigs, i.e. more than USD 4 per share, as the endgame is most likely M&A. Northern Ocean’s semis are substantially younger than the fleet of peers. Furthermore, the concentrated shareholder structure, 40% Hemen Holding Limited (indirectly controlled by John Fredriksen) is very helpful in that regard.
APPENDIX
Bollsta and Mira are the newest semis on the market, the fleets of peers are significantly older.
DEBT STRUTURE:
Northern Ocean’s gross debt consists of USD 390m to DNB due Q1 2025 at SOFR +3.5% (currently 7.8%) and USD 90m due Q2 2025 from Sterna at 6.75%. In both 2023 and 2024 NOL has to amortize USD 40m of the DNB facility, otherwise there are no near-term maturities.
The industry is already in consolidation mode:
RISKS:
Technical failure which might result in contract termination & extended contract free time
Major oil price decline
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
FCF growth
Dayrate increase
M&A in the industry