Is Now Finally the Time to Buy Offshore Drillers?

By Markets Fool.com

Few oil-related companies have been hurt as much by the oil crash as offshore drillers Transocean , SeaDrill , and Ensco . Many investors are asking: Is now the time to "be greedy when others are fearful," or should we wait to see if oil prices and the industry at large have bottomed? In my opinion, now may be the best time to snap up some great deals, despite continued short-to-medium term risks to the industry. Here's why.

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Undervalued, or value traps?

RIG Price to Tangible Book Value Chart
RIG Price to Tangible Book Value data by YCharts

As this chart shows, valuations for offshore drillers in terms of price/tangible book value and price/operating cash flow per share -- which I believe to be the best valuation metrics to use for this capital intensive industry -- have plunged over the past year. In fact on a price/tangible book basis -- which measures the market value of a stock against the value of its assets minus intangibles like patents or goodwill -- Transocean, SeaDrill, and Ensco are now trading at 56%, 42%, and 30% discounts to the value of their tangible assets, respectively.

RIG Price to Tangible Book Value Chart
RIG Price to Tangible Book Value data by YCharts

In addition, at today's prices investors are able to buy shares at very generous historical discounts to their 10-year average price/operating cash flow ratios. In fact Transocean, SeaDrill, and Ensco are now trading at historical P/OCF discounts of 84%, 71%, and 62%, respectively.

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Of course should oil prices remain low, and the offshore drilling industry's fortunes continue to deteriorate, then these enormous discounts might prove a classic value trap. But as long as investors dollar-cost average into truly long-term positions -- five-plus years as I see it -- I think there are two reasons to be optimistic about investing in these stocks.

Ferocious downturn is also a long-term industry opportunity;
I won't try to sugar coat it: The offshore drilling industry is facing a downturn that, in the words of Ensco's CEO, is "unprecedented". Day rates -- even on the most advanced ultradeepwater (UDW) -- rigs are plunging. What's worse, long-term contract cancellations are rising and SeaDrill's CFO says that the industry may not start to recover until 2017.

In the meantime offshore drillers are scrapping older rigs and taking enormous write downs that are devastating earnings. In fact, Transocean alone has already had to take impairment charges of over $3 billion to scrap 16 of its rigs in the last year, and may have to write off another $1.7 billionto scrap another 22 rigs in the future.

With the offshore drilling industry undergoing such a ferocious tumult, how can I possibly argue that now may be a good time to buy into it? The answer lies in my long-term optimism about the future of the industry.

Long-term growth catalysts still exist
First, any industry downturn this severe is likely to see an opportunity for industry consolidation, as stronger players snap up the assets of weaker, more distressed ones and gain market share as a result. However the strongest catalyst for future earnings growth is in the world's future oil demand, which is likely to be substantially larger than it is today.


In fact, a much larger world population, in accordance with a potential tripling in the size of the world economy by 2050, should result in $22.5 trillion in new investment by the oil industry over the coming three decades, courtesy of a 16% increase in oil demand according to the International Energy Agency.

With such enormous sums of investment cash likely to flow their way in the future, I think investors in offshore drillers need to keep their eyes on the long-term, bigger picture, no matter what short-to-medium term prices do.

Bottom line: Don't except a quick industry recovery but long-term investors may still do well to buy now
I won't lie to you and say that the next few quarters or even years won't be painful ones for offshore drillers, but for those companies that survive -- and I do believe that Transocean, SeaDrill, and Ensco will -- larger market share and stronger, more modern fleets are likely to bring returned prosperity, especially when day rates finally recover. The world's likely future oil demand should eventually cause oil prices to recover, and the opportunity for consolidation means that industry leaders such as these should make for good long-term investments -- especially at historically undervalued prices such as exist now.

The article Is Now Finally the Time to Buy Offshore Drillers? originally appeared on Fool.com.

Adam GalasleadsThe Grand Adventuredividend project, which owns shares of SeaDrill in several portfolios.The Motley Fool recommends Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.