Noble Corporation (NE, Financial) recently reported third-quarter results, and they were robust. Further, Noble will continue to deliver strong numbers in the coming quarters. This article discusses some of the key reasons to be bullish on Noble in an environment where most of the offshore drilling companies are struggling.
Reason one – Deleveraging
Unlike offshore drillers like Seadrill (SDRL, Financial) that still have significant capital expenditure, Noble has minimal capital expenditure in the next 12 to 24 months. This allows the company to utilize the free cash flow to reduce debt. As of the second quarter, Noble Corporation had $4.8 billion in debt, which reduced to $4.5 billion in the third quarter. I expect balance sheet deleveraging to continue in the coming quarters, and this will improve the company’s credit health. The key factor is that the company’s financial flexibility will remain high coming out of the crisis in the next 12 to 18 months. This will help Noble make investments in assets at the right time.
Reason two – Order backlog
Noble has a strong order backlog, and this will help the company generate decent revenue and cash flows even in challenging times. For 2016, Noble has a backlog of $2.5 billion, and the company’s order backlog for 2017 is $1.7 billion. The order backlog for 2017 should improve in the next 12 to 15 months. For 2016, the order backlog of $2.5 billion will ensure that operating cash flow is well in excess of $1.0 billion. In other words, Noble Corporation will remain free cash flow positive with the company likely to incur a capital expenditure of $800 million for the year. Even for 2017, if the order backlog improves, the operating cash flow visibility will be in excess of $1.0 billion. Therefore, the cash inflow will remain robust and this takes care of debt servicing as well as capital expenditure without the need for additional debt.
Reason three – Lower dividends
Recently, Noble announced that it will reduce quarterly dividends from 37.5 cents per share to 15 cents per share. While this might be seen as near-term negative, I view this decision by the management as positive considering the industry outlook. To put things into perspective, the reduction in dividends is likely to result in annual cash savings of $220 million and this can be utilized to strengthen the balance sheet or preserve cash buffer in uncertain times. With the industry outlook likely to remain challenging through 2016, I will not be surprised if dividends are suspended. This is likely to happen if there are no indications of gradual industry recovery towards the second half of 2016. Therefore, the key point here is a conservative approach that will be rewarding in the long term.
Besides these points, Noble has strong counterparty with 60% of the backlog with Shell. This ensures that the company’s revenue visibility is firm and the risk of order cancellations is relatively low.
From a risk perspective, the industry outlook remains challenging, and I believe that offshore drilling stocks have already discounted a difficult 2016. However, companies can witness further correction if oil prices sustain below $50 per barrel or trend lower instead of gradually trending higher. The markets expect gradual recovery for the offshore industry from 2017 and if there is no recovery indication towards the second half of 2016, there is likely to be further correction for all offshore drillers. Therefore, my recommendation is gradual exposure to quality stocks in the industry. Further, the investment horizon has to be long-term if substantial gains are expected.
