EUR 850.00 For Business Accounts Only

Morningstar | Adjusting Offshore Driller Fair Value Estimates on Revised Long-Term Rig Market Assumptions

After reviewing our long-term forecasts, we are revising our fair value estimates for offshore drillers. Diamond moves down to $7.25 per share from $10.50 previously, Transocean moves to $6.75 from $6.50, Ensco moves to $10.25 from $15, and Noble to $1.50 from $2.50. Our no-moat ratings for each of the names remain unchanged. With the exception of Transocean, our fair value estimates are moving significantly down as a result of more pessimistic long-term industry assumptions.

In the floater market, we now forecast a midcycle (2028) rig supply of 240 rigs, about in line with year-end 2018 levels of 242, as we forecast 29 rig retirements being nearly offset by 27 rig newbuild deliveries (most of which were ordered prior to the industry downturn). We forecast rig demand to increase from about 125 in 2018 to 170 in 2028, but this will only be enough to lift utilization to about 71%. Low utilization will result in day rates remaining about 20% below 2014 (pre-downturn) levels.

In the jackup market, we now forecast a midcycle (2028) rig supply of about 520 rigs, in line with year-end 2018 levels. As with the floater market, flat rig supply is due to rig retirements being offset by rig newbuild deliveries. We forecast rig demand to increase from about 290 to 340 in 2028, but this will only be enough to lift utilization to about 67%. Low utilization will result in day rates remaining about 30% below 2014 (pre-downturn) levels.

In contrast to the rest of the group, we are slightly increasing our Transocean fair value estimate. This is due chiefly to a reconsideration of the company's harsh environment floaters (accounting for about one-quarter of the company's rigs after recent acquisitions and divestitures), which we think will benefit from a very strong harsh environment market, driven by demand in the North Sea and Canada as well as tight specifications that will largely prevent the entrance of non-purpose built rigs from other regions.

We have increased our cost of capital for Noble to 9.1% (vs. about 8.7% for the rest of the drillers) owing to financial distress concerns. Noble is much more leveraged than its peers, with debt to fair value of equity of about 8 times versus 2 to 3 times for peers. Deferred debt maturities (about 40% of its debt doesn't come due until the early 2040s) will help Noble, but still we think there is some distress risk.

As a group we think the offshore drillers look about fairly valued, following a 45% to 65% share price fall for drillers over the past year. Relative to other oilfield service companies (which look undervalued on average), the offshore drillers look expensive, as plausibly the market is overrating the ability of rig retirements to balance industry supply and demand. To be sure, rig retirements have helped immensely in recent years--120 floater rigs were retired from 2014 to 2018 (compared with the fleet size of about 240 rigs today). However, most of these were older rigs, and unfortunately for the drillers there are too many newer rigs (which are unlikely to be retired) remaining in the current fleet for retirement to be an effective cure for oversupply.

Among the drillers, Ensco looks the most attractively priced, trading about 15% below our fair value estimate (but still well within 3-star territory given our extreme uncertainty rating). This discrepancy versus peers has developed as a result of share price underperformance over the past two months. We think the market has grown overly pessimistic regarding the benefits of the company's recently closed merger with Rowan.