Ocean Rig (ORIG, Financial) has surged by 30% since March 19. The rally has been fueled by oil prices trending higher in the recent past. However investors still need to remain cautious and avoid exposure at current levels. This article discusses the reason for this view on Ocean Rig.
I must mention that I have been positive in the past on Ocean Rig when the offshore drilling market was robust. However, with the slump in oil prices and other factors to be discussed in the article, there are reasons to remain cautious.
Coming to the positives first, Ocean Rig has one of the most modern rig fleets in the industry and a modern fleet coupled with good contract coverage for 2015 is a reason to be positive from a cash-flow visibility perspective. For 2015, the company’s contract coverage is 93%, and this is likely to ensure stable revenue and EBITDA if there are no contract cancellations in the coming quarters.
I mention contract cancellations as Ocean Rig has few contracts with Petrobras and the company has been struggling due to the corruption scandal. Cancellation of one or more contracts with Petrobras can impact the revenue and cash flow visibility significantly, and these risk factors need to be discounted while considering exposure to Ocean Rig.
Another big reason to be cautious on Ocean Rig for the near term is the fact that DryShips (DRYS, Financial) owns 59.2% stake in Ocean Rig. This is a matter of concern as DryShips is struggling, and the stock has declined by 75% in the last year. The slowdown in China has impacted the dry bulk shipping industry and with China’s growth expected to remain sluggish DryShips will remain depressed in the coming quarters. In 2014, Ocean Rig had signed a $120 million loan facility for DryShips and that loan facility for the latter is a concern for Ocean Rig.
Therefore, both the concerns for Ocean Rig are related to other parties. As I mentioned earlier, Ocean Rig has an excellent rig fleet and this ensures that the company is attractive on a stand-alone basis. However, industry factors remain significantly challenging and can impact Ocean Rig’s revenue outlook. Further, investors need to wait and watch for DryShips and the potential of the company to service debt.
Once there is more clarity on these two factors, a bigger position in Ocean Rig can be considered. I must mention here that the nuclear deal with Iran also implies that oil supply is likely to increase in the later part of 2015 or in 2016. Therefore, I don’t expect oil to surge in 2015 and 2016. Oil will continue to remain sideways once supply resumes from Iran. In other words, the offshore drilling market is also unlikely to recover anytime soon. Ocean Rig is well positioned with long-term contracts, but the risk relates to potential cancellation of the contracts if energy prices remain weak for a prolonged period. In particular, the contracts with Petrobras carry a high risk of cancellation.
Considering these factors, it would be best to avoid Ocean Rig at current levels. I emphasize again that the company is excellent from a fleet perspective, but external factors are likely to dominate in the foreseeable future.
