Login

Odfjell Drilling ODL
September 26, 2023 - 12:18pm EST by
taiidea
2023 2024
Price: 34.75 EPS 2.26 4.21
Shares Out. (in M): 244 P/E 15.3 8.2
Market Cap (in $M): 784 P/FCF 8.3 7.3
Net Debt (in $M): 706 EBIT 124 138
TEV (in $M): 1 TEV/EBIT 12.0 10.8

Sign up for free guest access to view investment idea with a 45 days delay.

 

Description

LONG: Odfjell Drilling (ODL.NO)

Summary

Odfjell Drilling is the owner and operator of the largest pure-play harsh environment ultra deepwater offshore drilling fleet in the world. The company owns four modern semi-submersibles and manages another four for a fixed fee on behalf of Northern Ocean, SFL, and CIMC Offshore.

Many value investors are familiar with the offshore drilling sector thesis, as peers Noble, Valaris, Transocean, and ancillary service providers like Tidewater have been widely discussed on VIC and elsewhere. We will provide some background on the sector dynamics and then attempt to answer two key questions: why is the harsh environment (HE) segment the most compelling, and why does Odfjell Drilling offer better risk/reward than liquid US-listed peers?

We believe Odfjell Drilling offers upside of 3-5x within the next two years, with downside protection, in the form of shareholder capital returns, unrivaled in the sector.

Company History

The Odfjell group of companies has owned and operated marine assets from tankers to terminals since 1914. In 1973 Odfjell Drilling and Consulting was established, led by Abraham Odfjell, and in 2007 he transferred ownership of the offshore drilling business to his two daughters, Helene and Marianne, while Abraham’s son took over a separate tanker business.

In 2013 Odfjell Drilling went public near the peak of the last cycle, with Marianne selling her entire 30% stake for over $400mn; Helene retains a controlling shareholding with just over 60% ownership in the company today. Helene Odfjell has had to steer the company for ten years through what is widely regarded as one of the worst downcycles in shipping history. For a sector that once boasted an aggregate enterprise value in excess of $100bn, with many multi-billion-dollar market-cap companies, only two meaningful companies have survived without being sold, scrapped, or going bankrupt: Transocean and Odfjell Drilling.

Over the listed history of Odfjell Drilling, the company reduced its average fleet age, spun-off its well services business, and emerged as the best-positioned to take advantage of the current cycle upturn.

Sector Background

Offshore drilling assets can be segmented into two broad groups:

  • Jack-up rigs – These can drill at depths of up to 400 ft and are “jacked” to the sea floor. They are generally immobile but more commoditized, costing ~$200mn each in the last cycle. There are an estimated 483 jack-up rigs in the market today, roughly two-thirds of which are considered modern. Of the 320 modern jack-ups, 257 are under contract, another 32 have been contracted for the future, 20 are warm-stacked (ready to be activated), and 11 are cold-stacked (requiring meaningful capex to reactivate).

  • Floaters – These are semi-submersibles and drillships that primarily operate in the ultra deepwater (UDW) segment of the market, drilling at depths of up to 12,000 ft. Because they do not rest on the sea floor, they are mobile and more technologically advanced, costing $600-$700mn each in the last cycle. There are a small number of shallow water floaters as well, but the UDW market is further segmented into HE semi-submersibles, which have advanced thrusting and mooring systems that allow operations in high wind and waves (primarily in the North Sea), and benign environment (Gulf of Mexico, West Africa) semi-submersibles and drillships. Importantly HE floaters can operate in benign environments, but benign UDW floaters cannot operate in harsh environments. There are also increasingly attractive new prospects, such as the TotalEnergies Venus project off of southern Namibia, where benign environment project owners have shown a preference for HE semi-submersibles.

The market for UDW vessels is tighter than the market for jack-ups, and the market for HE UDW vessels is tighter than for benign UDW vessels. See the table below for the current universe of offshore drilling assets:

 

Offshore drilling has gone through many cycles, but the most relevant cycle for this discussion is the post-financial crisis cycle that lasted from ~2010-2014. Offshore drilling generally becomes economically feasible with WTI between $30-$60/bbl, with varying probabilities, and comfortably feasible with higher prices. With WTI stable at $85-$110/bbl between 2010-2014, and alternative oil sources running low vs. the prior cycle, UDW drillers saw new-contract pricing rise from ~$400k/day to over $600k/day within two years. Cash operating costs range from $120-$200k/day, excluding capex, and contracts last for a few months to several years.

Offshore drillers followed higher pricing with a frenzy of newbuild orders. Dozens of UDW semi-submersibles and drillships were ordered between 2012 and 2013. The appetite for risk was so high that, even as the market began stabilizing in mid-2013, Seadrill alone ordered four UDW vessels in 3Q13.

With E&P offshore capex declining (see chart further below), contract prices began to collapse in 2015, and by 2018 pricing had reached a level so low only the most efficiently managed vessels could operate at cost and avoid scrapping or idling.

The first chart below shows the historical average day rates for HE and benign UDW vessels over the past cycle, while the second scatter chart shows granular data over a longer horizon:

 

 

 

In the downturn offshore drilling shareholders lost tens of billions of dollars, banks and shipyards lost billions more. An estimated 46% of floaters were scrapped between 2015 and 2022. Here is a representative comp table of drillers on the brink of liquidation, bankruptcy, and consolidation, from May 2015 by JP Morgan: