Description

Odfjell Drilling (ODL NO) is a best-in-class recently listed offshore driller with three 100%-owned 6th generation harsh environment ultra deepwater (UDW) rigs and one 1980s-built midwater rig in the Norwegian Continental Shelf (NCS).  The company also has a 40% stake in two UDW drillships through a JV with Metro Exploration.  Besides the mobile offshore drilling rigs, the company is an experienced platform driller, operating 19 production platforms in the North Sea.  The company also provides well services and rental of well equipment for exploration and production purposes, and has in-house engineering capabilities supporting the other businesses.  Despite a relatively young, highly specialized fleet, the stock trades at a roughly 30% discount to peers which we expect to close within 12-18 months. 

1) Mobile Offshore Drilling Units (MODUs) (70% of 2013 EBITDA)

• Deepsea Stavanger (100% owned UDW semi, 2010) at $420/day with BP, up for renewal in 2015, likely to price at $550-600/day
• Deepsea Atlantic (100% owned UDW semi, 2009) at $561-576/day with Statoil through 2017
• Deepsea Bergen (100% owned midwater semi, 1984) at $354/day with Statoil through 2018
• Deepsea Aberdeen (100% owned UDW semi, 2014) at $455/day with BP through 2018, should be in operation by late 2014
• Deepsea Metro I (40% owned UDW drillship, 2011) at $575-684/day with BG/Ophir through 2016
• Deepsea Metro II (40% owned UDW drillship, 2011) at $432/day with Petrobras, up for renewal in 2015, likely to price at $550-600/day

EBITDA from this segment to grow by 35% from 2013 to 2015 ($280M to $380M) as contracts reprice higher and Aberdeen comes online.  The company also has 10% stakes in 3 UDW newbuild drillships to be built in Brazil from 2016 to 2018.  The rigs have 15 year charters with Petrobras upon delivery at $518-529/day.  The rigs have a yard cost of $793M, ODL is on the hook for just $45M.

2) Well Services (25% of 2013 EBITDA)

• Provides casing and tubular running services, rental of tools and drilling tubular equipment for exploration and production.
• Key service contracts with Statoil, Shell, BP for casing and tubular running services, rental service contracts with Schlumberger, Halliburton, Maersk Drilling, etc.  Client relationships go back over a decade. 
• Revenue has grown at a 12% CAGR from 2009 to 2012 with steady EBITDA margin in the mid 40% range.  Expect to see continued double digit growth in line with the overall offshore tubular services market which is dominated by Weatherford, Frank's International with 30% market share each
• EBITDA from this segment to grow 20% from $100M in 2013 to $120M by 2015. 

• Provides production drilling and completion drilling on client's fixed and floating production platforms.  Contracts with 19 platforms in the NCS and the UK Continental Shelf.   
• Platform drilling is a stable business with low margins.  Growth comes from new awards rather than price increases.  Competitors are Archer and KCA Deutag. 
• Company also offers engineering services, project management and operational support for newbuild projects.  Since 1973, company has been involved in 31 newbuild projects and over 70 commissioning, upgrade and renewal projects on fixed and floating drilling units.
• EBITDA from this segment to grow about 25% from 2013 to 2015 (from $20M to $25M).

UDW Market Outlook

• The ultra deepwater segment of the offshore drilling industry has a strong outlook due to the large number of deepwater discoveries in the past several years that have yet to be developed.  There are 22 newbuilds scheduled for delivery through year-end 2015 while most demand models point to incremental demand of 30-40 units.  New orders will not be deliverable until 2016 at the earliest, suggesting good visibility. 
• Within the UDW sector, harsh environment rigs benefit from the strict guidelines required to operate in cold, harsh climates.  This differentiation was proved out in the 2008-9 recession where day rates in the NCS were far more resilient than those in the more traditional UDW market.  One other positive force in the NCS is the aging fleet, with half of the existing fleet aged 25 years or older.  Following the Macondo/Deepwater Horizon accident, operators are showing a preference for newer equipment.  The fact that BP chose Odfjell as the drilling contractor for the Deepsea Aberdeen newbuild in 2012 is a testament to Odfjell's status as a best-in class contractor. 

Valuation

• ODL NO trades at an EV/EBITDA of 4.8X (FY15E) vs the peer group average of 6.0X and it trades on an EV/UDW rig (FY15E) of $564M vs the peer group average of $723M.  Given its exposure to the lucrative and protected harsh environment UDW market, its well respected management team, and the superior free cash flow profile (16% yield in FY15E), we believe it should trade much closer to the peer average.  At 5.7X, it would trade at NOK 57 for 33% upside. 
• Note that capex peaks in 2014 at around $700M, $585M of which is earmarked for Deepsea Aberdeen.  Capex then ramps down to $170M in 2015 and $90M in 2016 (roughly equal to maintenance level)
• Total debt as of 6/30/13 is $1.36B (vs cash of $245M).  The company has an undrawn $530M credit facility for the financing of UDW newbuild Deepsea Aberdeen in 2014 at a rate of 4%.

Risks

• Watch for any signs of a flattening or rolling over in UDW dayrates.  The market is currently tight and expected to remain tight for the next several years, but there are some wild cards, notably Brazil.  Petrobras has not contracted any new UDWs since 2011 due to disappointing production growth and a stretched balance sheet.  The Brazilian fleet is expected to remain flat through 2015, with all the growth in demand coming from West Africa and the Gulf of Mexico. 
• While the company would point to the resilience of the harsh environment UDW market in previous recessions as a mitigating factor, this is still an indirect bet on oil prices remaining firm - any significant and sustained downward pressure on international oil prices (Brent) would likely have ripple effects through even the best-positioned segments of the UDW market. 

Catalyst

• Blackout period for the Street just ended this week.  First coverage by Pareto was bullish, with NOK 55.00 price target.  Expect coverage by Danske, ABG, Carnegie, DNB among others, with an overall bullish tone.  Company is well known by locals, but less well known in the international investment community. 
• Delivery of Deepsea Aberdeen 6th generation UDW scheduled in May 2014.  7 yr contract with BP commences in 4Q14.
• Deepsea Stavanger and Deepsea Metro II have contracts up for renewal in 2015 and are well below market rates - expect a significant uplift in a much lighter capex year, leading to significant free cash flow.