Jun 3, 2010
From Oil Spills to Opportunities
A lot of investors are fixated on BP plc (NYSE:) and Transocean (NYSE:) because they are in the headlines so much. I think that part of the reason stems from the fact that investors like to be involved in the things they read about. There is a certain level of excitement.
I saw this same behavior during the financial crisis. Most people end up becoming obsessed with certain stocks just because they are constantly in the news. I can see the appeal, it gives you something that you can bring up in conversations with your friends. But often, it is not really prudent investing.
BP and RIG both face liabilities that are extremely difficult to estimate. BP has already agreed to pay for the costs of the cleanup, but as long as the oil keeps leaking, the costs will continue to rise. Credit Suisse analysts have come out saying that the costs may reach $37B or 9 times the cost of the Exxon Valdez spill. That is up from $10B a few weeks ago. With the public outraged and Attorney General investigating BP for possible criminal charges, there is a lot of uncertainty here. I just don’t think any one investor can truly figure out the risks in a situation like this with any accuracy.
Now, that is not to say there aren’t opportunities out there stemming from the oil spill.
Here are a few companies that I am researching right now. I still have a lot to read, but some of these look very interesting at current prices and all have been affected by the spill in one way or another. The benefit though is that they lack the headline risk and may ultimately be safer investments:
1. Ensco (NYSE:)
Ensco is an offshore contract drilling company. As of February 15, 2010, Ensco’s offshore rig fleet included 42 jackup rigs, four ultra-deepwater semisubmersible rigs and one barge rig. Additionally, it had four ultra-deepwater semisubmersible rigs under construction. Ensco’s operations are concentrated in the regions of Asia Pacific, which includes Asia, the Middle East and Australia, Europe and Africa, and North and South America. It operates under four segments: Deepwater, Asia Pacific, Europe and Africa, and North and South America. Each of the four operating segments provides one service, contract drilling. Ensco engages in the drilling of offshore oil and natural gas wells by providing its drilling rigs and crews under contracts with international, government-owned and independent oil and gas companies.
At current prices, Ensco looks pretty cheap. Yes, a moratorium on offshore drilling would undoubtedly cause them to take a bit of a hit. But, think about it this way. You are getting a company that has been clobbered almost as bad as BP and RIG (about a 4% difference month-to-date).
However, you are also getting a company without the headline risk, substantial operations abroad to make up for any lost revenues during the drilling moratorium, and a clean balance sheet with $1B in net cash. If there really is a 6 month drilling moratorium, you can bet that some of the more leveraged players will be in for some pain. Plus, drilling rig premiums are going up, putting even more pressure on them. This might create some good bargains for a company like Ensco which could come in and buy rigs on the cheap from financially squeezed competitors.
The biggest risk with a company like Ensco is that its earnings could go down if the price of oil declines. With the risk of China’s economy slowing down, this is a possibility, but I think that in the long run the BRIC countries are here to stay and will ultimately drive energy prices higher.
Ensco looks pretty nice at around 7x earnings, 1x book, $1B in net cash, and a 4% dividend yield.
2. Tidewater (NYSE:)
Tidewater Inc. provides offshore supply vessels and marine support services to the offshore energy industry through the operation of offshore marine service vessels. As of March 31, 2008, the Company had a total of 430 vessels, of which 10 were operated through joint ventures, 61 were stacked and 11 vessels withdrawn from service.
Tidewater is another company I started to look at. Again, these guys lack the headline risk, but still operate in the same industry and might take a hit from the moratorium. They operate shipping vessels for the O&G industry. A decline in drilling activity and energy prices would negatively impact their business.
On the plus side, TDW has a great record of capital allocation. When activity slows down, they have proven themselves to be incredibly adept at selling under-utilized vessels to companies in non-competing industries at prices in excess of cost.
Tidewater trades at 8.3x earnings, 88% of book value, and has a clean balance sheet with a 3% debt to equity ratio when you net out cash.
The risk here is again, if oil prices decline, rig activity slows down which also affects Tidewater. This has already happened and net income dropped from $407M to $259M YoY. In addition, the company has taken a few small charges $37M in provisions for vessels seized by Venezuela and $11.4M to the SEC for a bribery complaint related to operations in Nigeria. I can imagine that some of these may make investors nervous, but they seem quite frequent among companies in the O&G business that operate abroad.
3. HCC Insurance (NYSE:)
HCC Insurance Holdings, Inc. (HCC) provides specialized property and casualty, surety, and group life, accident and health insurance coverages and agency services to commercial customers and individuals. The Company operates its businesses in three segments: insurance company, agency and other operations. It operates primarily in the United States, the United Kingdom, Spain and Ireland. It underwrites on both a direct basis, where it insures a risk in exchange for a premium, and on a reinsurance (assumed) basis, where it insures all or a portion of another, or ceding, insurance company’s risk in exchange for all or a portion of the ceding insurance company’s premium for the risk. HCC markets its products both directly to customers and through a network of independent and affiliated brokers, producers, agents and third party administrators.
These guys are expecting to take a $30 to $40M hit from the oil spill (they did $350M pre-tax last year). They seem to be running a really tight ship when it comes to underwriting, the last 3 years have been hovering around 85% combined ratio and have a good record of book value growth (15.7% CAGR since 2001). They have the lowest expense ratio in the industry, about 5% lower than peers, a nice little advantage.
The company is trading around 90% of book, historically over the last 5 years they have traded around 1.5x.
About 95% of shares are held by institutions, with 115M shares outstanding. The company just announced a $300M stock buyback, they just finished up their last buyback program ($100M, started in 2008). I think that might add some pressure to bring the stock price up, it has traded sideways the last few years.
It looks like an opportunity to get a good insurer at a good price.