Atwood Oceanics – Value Play or Value Trap?

Extract from its latest filing on industry conditions in May 2017

The offshore drilling industry remains in the midst of a very severe downturn that began in the second half of calendar year 2014. Since that time, the industry has experienced declining demand for drilling rigs that has been exacerbated by a sharp decline in oil prices. E&P companies generally reduced their offshore capital spending in 2015 and 2016 by canceling or deferring planned drilling programs, and this trend is expected to continue into the second half of calendar year 2017. Since declining to multi-year lows below $30 per barrel in early 2016, Brent oil prices recovered modestly during the latter part of 2016 and ranged between $50 and $55 per barrel in April 2017. However, we expect offshore rig demand to continue declining during the first half of calendar year 2017 and potentially beyond, as offshore rigs complete existing contracts at a faster rate than new drilling programs are initiated. Declines in offshore drilling demand and the associated reductions in rig utilization and day rates could materially and adversely affect our financial position, results of operation or cash flows. See “Our business depends on the level of activity in the oil and natural gas industry, which is significantly impacted by the volatility in oil and natural gas prices” under “Risk Factors” Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2016.
Even as offshore rig demand declined from the peak levels in calendar year 2014, some drilling contractors continued to take delivery of new, more capable rigs that were ordered prior to the industry downturn. However, over the past year drilling contractors have generally delayed further rig deliveries, especially for uncontracted rigs, through renegotiation of terms with the shipyards that are constructing these rigs. Due to the confluence of an oversupply of offshore rigs and declining rig demand, a lower percentage of marketed rigs are being re-contracted, and day rates and utilization have declined sharply across all offshore rig classes. While clients generally prefer newer, high specification rigs over older, less capable rigs, many newer floaters and jackups have been idled or cold-stacked as drilling demand has declined across all regions, water depths and rig classes. The bifurcation trend of higher utilization rates for newer, more capable rigs has been generally muted, but has been maintained more consistently for floaters than for jackups.
Due to the uncertain duration of the current industry downturn, a growing number of older, less capable rigs have been permanently removed from the marketed supply of rigs by virtue of being scrapped, announced for scrapping, or cold stacked.
There are a few key risks highlighted as below:
  • Offshore drilling industry severe downturn. Even though there are less floaters and jackups, the supply still exceeds demand
  • Reduction in rig utilization
  • Decrease in day rates

In the latest reports, Atwood has

  • Negative operating income
  • Issue new shares to raise capital ( jump from 64M to 80M)
  • Issue new debt to finance
  • Considerable depreciation expenses

In its May 17 Fleet status:

  • The day rate for well in progress is lower than the contract day rate and is not disclosed.
  • Deep water semisubmersible scraped
  • 4 out 5 jackups are idling
  • One out of two ultra deep water semi-submersible is idling in the period Sep 17 to Mar 18
  • Current fleet utilization is about 50 percent

Metrics based on gurufocus:

  • Net cash value:  -11.93
  • Net current asset value: -9.46
  • Tangible book value 42.24
  • Days inventory increased from 104 to 140 from 2016 to 2017

For value play, most look at the tangible book value. But from above, we can see many risks involved and I have doubts about the tangible book value as many of the company assets can’t be sold at the market price with the current downturn and that might look like it will stay for a couple of years with the depressed crude price.

Hence, ATW is a value trap and I would short it if it reaches above $12.

Disclosure: I do not hold any positions on ATW.

Would passive investing in ETF/Index funds be the next bubble?

Woke up this morning thinking of the recent hype about passive investing through index/ETFs.

With the recent “advice” by Warren Buffett on it’s better to invest in ETFs rather than an active manager, pretty sure that there will be a greater inflow of funds into ETFs, causing a short-term momentum up. The theory of reflexivity also explains that this will further push the price up. It has also been brought to my attention that with that, many more retail investors might put in more money into ETF esp S&P500.

The impact for this is that there will be a widening difference in valuation between stocks in the S&P 500 and those that aren’t. Companies in the S&P500 will just get pricier. And the bubble might burst once a crisis hit or a bad earnings quarter and investors start to flee the ETFs. Because of their fund structure, it’s not easy for the ETF to exit and they will lose money due to the volatile spreads happening in a crash, causing the index to fall further.

And one thing about Warren Buffett, sometimes his words are different from his actions. He did not invest in any index/ETF funds. Do what he does but not what he says.
What are your thoughts on this?

 

Energy Sector Summary

Two main industries

  • Oil, Gas & Consumable Fuels
  • Energy Equipment & Services

Oil, Gas & Consumable Fuels

Companies engaging in the exploration, production, delivery, refining and marketing of petroleum products to consumers are all part of the integrated process

  • Upstream: exploration, taking the resources out of ground and selling them. E.g. Devon Energy, Anadarko Petroluem, Apache
  • Midstream: Processing, storage, and transportation of hydro-carbons including ships, pipes. E.g. TransCanada, Williams Companies, Enbridge, KMI
  • Downstream: Refining oil and natural gas into usable products. E.g. Valero, Sunoco, Tesoro
  • Well known giants like Exxon, Chevron, BP, Shell engaged in all three segments
Key Characteristics
Upstream Exploration and Production. Big profits but bigger risks, negotiating with unpredictable foreign governments. Capital intensive.

Two types of reserve – unconventional and conventional.

Conventional – Trapped between layers of rock and can be extracted using ground pressure

Unconventional – oil sands and shale and extracted through a more costlier mining process. Canada contains tar sands and estimated second largest behind Saudi and oil shale in North America estimated to be the biggest

Midstream Most often done via ships and pipes
Downstream Profit margins much slimmer than exploration and production

Upstream

  • Six steps
  • Acquire the rights to explore for and develop oil and gas from reserve holder
  • Conduct geological, geophysical and seismic surveys to find oil and gas deposits
  • Perform exploration drilling to test for deposits
  • Conduct appraisal and development drilling to determine if the field contains commercially viable deposits
  • Begin oil and gas production (or abandon if no deposits found)
  • Ensure payment to compensate reserve holders via royalties and/or production sharing agreements

Midstream

  • Transportation methods depend on hydrocarbon type
  • Crude usually tankers, pipelines, rails,trucks or even planes
  • Natural gas mainly pipelines. If by ships, it need to be cooled to LNG and requires special terminals and ships

Downstream

  • Includes refining and processing crude oil into petroleum products
  • Refineries produce petroleum products based on location and demand
  • Differences in Crude Oil
    • Light versus Heavy Crude refers to the density, or weight per volume, measured as American Petroleum Institute gravity (API gravity), expressed in degrees. The higher the API gravity, the greater the density. Heavy – API < 22 degrees, light – API >38. Light is more valuable than heavy because it’s less expensive to refine and has higher energy content
    • Sweet versus sour crude refers to the sulfur content of oil. Sweet contains less sulfur and is more valuable
  • Marketing & Distribution: Retail stations reflect the entire integrated process.

Energy Equipment & Service Industry

Firms assist oil and gas firms with exploring, drilling and producing reserves but they generally don’t own oil and gas directly and hired by pure upstream and integrated firms.

Two main types

  • Oil & Gas Drilling
    • Rigs used for exploring that is rented out such as Seadrill, Transocean, Diamond Offshore Drilling
  • Energy Equipment & Services such as Schlumberger, Halliburton, Baker Huges
    • Drilling equipment (NOV)
    • Pressure pumping services
    • Wireline services
    • Directional Drilling and measurements
    • Seismic imaging and analysis
    • Engineering and construction services: Designing, building, operating oil and gas infra
    • Helicopters and boats: Transportation services like ferrying (KNOP)

Key Drivers of the Energy Sector

  • Commodity prices
  • Oil and gas production growth
  • Finding and development costs
  • Exploration and production capital expenditures
  • Refining margins
  • Share buybacks and mergers and acquisitions (M&A)
  • Sentiment
  • Taxes, Politics, and regulations
  • Absolute and relative oil and natural gas prices are the most influential factor

Oil Demand Drivers

  • Global Economic growth, growth in oil demand has followed world GDP growth fairly consistently
  • List of countries by oil consumption
  • Breakdown of Oil use
    • Transportation (69 percent)
    • Industrial (24 percent)
    • Residential (4 percent)
    • Electricity Generation (2 percent)
    • Commercial (1 percent)

Oil Supply Drivers

Natural Gas Demand Drivers

  • Natural gas used for different purposes and difficult to transport from large reserve to global end users
  • Driven by combination of economic activity and weather
  • Breakdown of US Natural Gas Use
    • Electricity Generation (39.5)
    • Industrial (30.5)
    • Residential (17.4)
    • Commercial(12.4)
    • Vehicle (0.2)

Natural Gas Supply Drivers

Additional Drivers

  • Oil and Gas Production Growth
    • Oil firms can grow through organic by increasing production or through acquisitions
    • Widely followed performance measure is the reserve replacement ratio, measures the ratio of a company’s increase in reserves to its oil and gas production annually. Reserve ratio more than 100 means a growth in reserves.
  • Finding and Development Costs
    • Costs generally rise and fall in concert with hydrocarbon prices
    • Firms within Energy Equipment & Services industry may benefit directly from rising finding and development costs
    • Costs are usually expressed as dollars per barrel of oil equivalent (BOE)
  • Exploration and Production Capital Expenditure
  • Refining Margins, differ greatly depending on the country or region
  • Share Buybacks and M&A Activity
  • Sentiment
  • Taxes, Politics and Regulations

Breakdown of Energy Industry based on GICS

Energy Equipment & Services Oil & Gas Drilling
Drilling contractors or owners of drilling rigs that contract their services for drilling wells
Oil & Gas Equipment & Services
Manufacturers of equipment, including drilling rigs and equipment, and providers of supplies and services to companies involved in the drilling, evaluation and completion of oil and gas wells.
Oil, Gas & Consumable Fuels Integrated Oil & Gas
Integrated oil companies engaged in the exploration & production of oil and gas, as well as at least one other significant activity in either refining, marketing and transportation, or chemicals.
Oil & Gas Exploration & Production
Companies engaged in the exploration and production of oil and gas not classified elsewhere.
Oil & Gas Refining & Marketing
Companies engaged in the refining and marketing of oil, gas and/or refined products not classified in the Integrated Oil & Gas or Independent Power Producers & Energy Traders Sub-Industries.
Oil & Gas Storage & Transportation
Companies engaged in the storage and/or transportation of oil, gas and/or refined products. Includes diversified midstream natural gas companies facing competitive markets, oil and refined product pipelines, coal slurry pipelines and oil & gas shipping companies.
Coal & Consumable Fuels
Companies primarily involved in the production and mining of coal, related products and other consumable fuels related to the generation of energy.  Excludes companies primarily producing gases classified in the Industrial Gases sub-industry and companies primarily mining for metallurgical (coking) coal used for steel production.

 

  • Integrated Oil & Gas sub-industry is by far the largest by market cap
  • Many of the world’s most significant Integrated Oil & Gas companies are owned by foreign governments and are not publicly traded. At the present moment, Saudi is looking at privatizing theirs.
  • Majority of publicly traded Oil & Gas exploration firms are in the US
  • Another US heavy industry is Energy Equipment and Services
  • Oil & Gas Refining & Marketing is a relatively small weight except for Emerging Markets
  • Smallest are oil & gas storage & transportation and coal & consumable fuels. Storage and transportation are almost entirely concentrated in the US and Canada.
  • Top 250 energy companies

Oil, Gas & Consumable Fuels Industry – Sub Industries

  • Integrated Oil & Gas (upstream and downstream)
  • Oil & Gas Exploration & Production (upstream)
  • Oil & Gas Refining & Marketing (downstream)
  • Oil & Gas Storage & Transportation (midstream)
  • Coal & Consumable Fuels (coal and uranium mining)

Oil & Gas Drilling

Oil & Gas Drilling (OGD) firms own and operate the rigs responsible for exploration and production activities. Their main customers are mainly exploration companies, IOCs and NOCs. Their main business is contract drilling. Main type of rigs are as below:

  1. Land Rig – Designed to drill on dry land and heavy duty ones can drill over 30,000 feet.
  2. Submersible – Offshore rig floating on water when moved but is submerged to the lower part of the rig hits the seafloor. Typically operates in wetlands and water depth up to 85 feet, drilling over 30,000 feet.
  3. Jack-up – Offshore rig with legs extending to sea floor. Generally, operates in shallow waters less than 400 feet deep but can drill over 30,000 feet.
  4. Semi-submersible – Offshore rig submerged a few feet below water surface and drill more than 30,000 feet, in water up to 10,000 feet deep.
  5. Drill ship – Ship drilling while floating on water surface, can drill more than 30,000 feet, in water up to 10,000 feet deep.

OGD firms have 2 growth strategies: building new rigs or growth through acquisition. Drilling is a boom-bust industry.

Oil & Gas Equipment & Services Sub-Industry

Similar to drillers, E&S firms’ main customers also include public and private oil and gas exploration and production firms, IOCs and NOCs, as well as drillers. Largest firm Schlumberger followed by Haliburton, Tenaris, National Oilwell Varco. E&S is extremely diverse and can operate in different sectors and activities.

Integrated Oil & Gas, Exploration & Production, and Refining & Marketing Sub-Industry Drivers

  • Oil and natural gas prices
  • Oil and gas production growth
  • Finding and development costs
  • Exploration and production capital expenditures
  • Share buybacks and m&A
  • Regulatory environment
  • Refining margins
  • Light/heavy spread

Oil & Gas Storage & Transporation Sub-industry drivers

  • Hydrocarbon volumes
  • Interest rates (affect interest expense and future growth plans), tend to be better with lower interest rates
  • Demand for defensive/high income-yielding securities

Coal & Consumable Fuels Sub-Industry Drivers

  • Coal prices
  • Transportation costs and bottlenecks
  • Exports/imports
  • Legislation/environmental regulation
  • Relative costs of alternative fuels

Energy Equipment & Service Drivers

  • Upstream Capital Expenditures
  • Oil and natural gas prices
  • Worldwide rig count
  • Dayrates

Instead of questioning if we will run out of energy resources, a better question to ask when will we reach the production peak? It is important as energy is cyclical and once it reaches a peak, there will be a down cycle. Other indicators look out is the reserves to oil consumption ratio. And to take note of the unconventional reserves.

Primary Factors affecting oil prices

  • Oil Demand
  • OPEC oil production
  • Non-OPEC Oil production
  • Spare oil production capacity
  • Global refining utilization
  • Global oil inventories

Primary factors affecting natural gas prices

  • Natural gas demand
  • Natural gas production
  • Natural gas/liquefied natural gas (LNG) imports
  • Natural gas storage inventories
  • Prices of natural gas substitutes

Refining Margin Fundamentals

  • Petroleum product demand (combination of economic activity and weather)
  • Crude oil prices (Falling is bullish)
  • Refining utilization
  • Petroleum product inventories
  • Petroleum product imports
  • Light/heavy spread

Energy Equipment & Services Fundamentals

 


Alternative Energy

Often refers to sources of energy other than those generated through fossil fuels like oil and natural gas, often termed as renewable energy.

4 distinct sectors

  • Power generation (largest)
  • hot water and space heating
  • transport fuels
  • rural (or off-grid) energy

Types of renewable

  • Water – Hydroelectric power is the leading renewable energy source. It has the advantage of being a cheap, reliable source of power capable of running 24 hours a day.
  • Ethanol and Other Biomass/waste – Produced from non-fossilized materials such as wood, waste, biofuels (ethanol and biodiesel). Ethanol mainly made from sugar
  • Wind – wind turbines relatively low maintenance but limitation to the weather. Transmission lines are also a factor
  • Solar – dependant on weather
  • Geothermal – being able to run 98 percent of time but limited to number of geothermal reservoirs
  • Nuclear Power – mainly from uranium but drawback is its risk

Alternative Energy Drivers

  • Oil and natural gas prices
  • Taxes, subsidies, politics and regulations (many are not economical and depends on subsidies)
  • Geopolitical environment
  • Technological advancements
  • Supply chain costs
  • Sentiment

Questions to ask when analyzing

Integrated Oil & Gas, Exploration & Production, and Refining & Marketing Sub-Industries

  1. How are the revenue and earnings divided between exploration and production, refining and marketing, or other divisions like petrochemicals?
  2. How are the firm’s production and reserves split between oil, natural gas, or some other mix?
  3. Is the firm consistently growing oil and gas production or experiencing declines? What is it production growth relative to peers? Is growth organic or due to acquisitions? What is the company’s strategy to grow oil and gas reserves?
  4. Is the company doing hedging and how exposed is the company’s operations to oil and gas prices?
  5. What is the history of the company reserve replacement? How many years can it sustain production with current reserves?
  6. How do the company’s finding and development costs, operating costs and exploration expenses compare with peers? Is the company a low cost producer or engaged in high-cost operations like oil sands, oil shale, or other unconventional resources?
  7. What is the company’s geopolitical risk profile? Where are most of the company’s current and future planned production sites and refining assets? Are the sites in politically stable or unstable countries? What percentage are in unstable countries? Does the company has a history of operating in foreign territories? Has the company ever face challenges and disruptions due to geopolitical problems?
  8. Are the company’s shares owned or controlled by the government?
  9. How is the company spending its cash flow?
  10. How complex are the company’s refineries? Does it do just one kind of refining or many? How diversified are the company’s sources and types of crude oil? Is it dependent on one supplier or many?
  11. What is the company’s mix of petroleum products (gasoline/diesel/heating oil/chemicals)?

Oil and Gas Storage & Transporation Industry

  1. What percentage of the company’s earnings are regulated? Does the company have production or trading asset? And which of the two are more important to the bottom line?
  2. What is the competitive landscape? Does the company operate in a region with a significant barrier to entry? Generally, pipelines face less competition.
  3. Does the company have the financial ability to make large acquisitions to fuel growth? Does the company’s balance sheet allow it to take on additional leverage?
  4. How are the company’s operations affected by regulation? Does the company operate in a favorable regulatory environment? How might that change? What is the company’s history with gaining regulatory approval for its projects?
  5. How sensitive are the company’s operations to interest rates? Are rising or falling rates good or bad for the company’s operations and share price?
  6. Does the company have a reliable history of paying and growing distributions to shareholders?
  7. Are there tax implications for investing in the firm?

Coal & Consumable Fuel Sub-industry

  1. What is the supply-demand environment for coal within the company’s countries of operation? How have prices been affected?
  2. What is the company’s production growth history? What is its strategy for increasing coal production?  Is growth organic or due to acquisitions?
  3. In which regions does the company generate its sale? Is the company an exporter or does main to its own country? Is the company beholden to trade problems with other regions?
  4. What are the company’s production costs relative to its peers? What factors are driving its production costs?
  5. Does the company benefit from vertical integration? To what degree is it reliant on other company in its operations?
  6. How does the company deliver its coal to end user? Are there bottlenecks and if so, how did the company responded?
  7. Are there legislative risks regarding carbon emissions in the company’s countries of operations that could materially affect operations?
  8. Does the company secure free market pricing for its coal or are prices set by the government?

Oil & Gas Drilling Sub-Industry

  1. What is the breakdown of the company’s rig fleet? Do these rigs drill primarily for natural gas or oil?
  2. Which type of contracts does the company use to contract its rigs? What percentage of its fleet use each?
  3. What has been the trend of the company’s dayrates? What is the potential for dayrate expansion once its rig contracts expire?
  4. When do the company’s current rig contracts expire? How many of the firm’s rigs are due to come off contract in the short or long term?
  5. Are the company’s rigs more technologically advanced than competitors? Do oil and gas companies pay a premium for the company’s rigs?
  6. Where are the rigs located? What are the supply-demand dynamics in each region? Is it the company’s strategy to stick to a specific region or expand geographically? How easily can it move its rig to more attractive locations?
  7. What percentage of the company’s rigs is in service? Is utilization growing, stable, or falling?
  8. What is the company’s strategy to grow its asset base? Does it plan to build new rigs or acquire a competitor? At what pace can it build new rigs?
  9. What is the average age of the company’s fleet? Is it expanding its rig fleet or retiring old rigs? To what extent will the company need to take rigs out of service for upgrades or maintenance?
  10. How do the company’s operating and maintenance costs compare with peers? What is the company’s strategy to mitigate industry cost inflation?

Oil & Gas Equipment & Services Sub-industry

  1. What is the breakdown of the company’s revenue and earnings between products and services? Do the company’s business rely on the spot market, long term contracts, or both? Are the company’s revenues coming mainly from new products or more mature ones?
  2. What drives demand for the company’s products and services? What is the competitive landscape for these products?
  3. Does the company possess any proprietary technologies or patents giving it a competitive edge? Does the company continually release new products or does it specialize in more mature markets?
  4. What is the company’s geographic mix? Does the company plan to focus on one region or expand geographically? Do its core competencies jibe with that strategy?
  5. What is the company’s market share in each of its business segments? Does the company have pricing power for its products and services?
  6. Does the company execute its projects on time and on budget? Does the company put cost contingencies in its contracts? Have projects ever been disrupted in the past due to unforeseen problems?
  7. How healthy is the company’s product backlog? Is it rising or falling? Do is competitors have a bigger or smaller backlog?