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JBL: Drilling for Dollars

John Layfield

The Middle East is a powder keg. No matter who is right or who is wrong in this mess between Israel and Lebanon, it is a mess that could get a lot worse.

I hope it is settled peacefully, but since I have no control over it, and with oil approaching $80 a barrel, there is no sense in not making some money.

With oil and gas becoming harder to find, drilling companies are sitting in the driver's seat. Global Santa Fe (GSF) and Ensco International (ESV) are two that are going to benefit.

In the first quarter, Global Santa Fe produced an operating profit of $180.8 million, a 237% increase from the year-earlier quarter. Earnings per share grew to 65 cents from 21 cents. In addition, Global Santa Fe announced a share-buyback program of $2 billion, which would reduce the shares outstanding by 10% to 15%.

Global Santa Fe accomplished these numbers by increasing the day rates of its rigs to $101,000 in the first quarter from $68,400 in the first quarter of 2005. The company also claimed projections would be for an increase of 40% this year for day rates.

Global Santa Fe didn't have to wait long. A month after the quarterly report, the company announced that four of its functioning 59 rigs had received four-year contracts with Saudi-based Aramco to leave the Gulf of Mexico for day rates in the mid-$160,000 range. Global Santa Fe said this contract was a record for it, and perhaps a record for the drilling industry.

The company also announced that its drilling backlog had reached $8 billion, from $7 billion in the prior year and $4.8 billion from the start of 2006.

There were a total of 148 rigs in the Gulf of Mexico in 2001, compared to 98 today; last year's hurricanes exacerbated the problem. This has increased Global Santa Fe's utilization rate from 91% to 94%. Despite 91 offshore rigs currently being built, compared to 10 in 2003, there just aren't enough rigs to go around. The result is that the contractors have tremendous pricing power, which they are using wisely.

The consensus estimate is for Global Santa Fe's EPS to climb to $7.47 next year, which would be an increase of 45% from this year's forecasted numbers of $4.04. Based on 2007 estimates, Global Santa Fe is trading with a P/E multiple just over 7. The projected five-year growth rate is also 45%, which means this stock is a steal. (Global Santa Fe is slated to report second-quarter results on Aug. 2; consensus estimates are for EPS of 87 cents on revenue of $766.66 million.)

This is not just a Global Santa Fe story. Ensco and Transocean (RIG) are also sitting in the driver's seat.

Ensco has seen day rates increase to over $103,000 this year, from $60,000 a year ago. It also announced a large move from the Gulf of Mexico, with a rig getting a day rate of over $200,000 for up to 24 months from a concern in Tunisia.

Excluding rigs in yards for inspection, upgrades and contract preparation, Ensco reported a 99% utilization rate for its jack-up rig.

Ensco has a P/E under 10 based on 2006 estimates; analysts forecast earnings growth of almost 37% for next year. This is another gift. (Ensco is scheduled to report on July 25; estimates are for earnings of $1.22 and revenue of $454.12 million.)

Transocean, which specializes in deep-ocean drilling, is up 15% since I first profiled it on Dec. 3; the stock is still a buy. Recently, Transocean announced a rig that had received a day rate of $184,500 in 2004 is set to receive over $520,000 a day from British Petroleum (BP) to stay in the Gulf of Mexico.

I believe that with so many jack-up rigs leaving the Gulf of Mexico for better rates elsewhere, natural gas prices will increase. Oil is a global commodity; natural gas is not. Oil will not show a significant increase, because the drilling is not being lost globally, but is being reallocated.

I believe this bodes well for natural gas stocks, like Anadarko Petroleum (APC) and Apache (APA), and for land drillers as well.

I profiled Patterson UTI and Bronco Drilling (BRNC) in late February, and I have taken a bath on both of these land drillers. However, their utilization rates remain high, and they will continue to remain high due to natural gas prices. I still own and continue to recommend these stocks.

Remember, being poor is bad, staying that way is stupid.