Strong Revenue Growth and Premium Harsh Environment Drill Rigs Will Power Dividend Growth and Share Price Appreciation

North Atlantic Drilling Limited (NADL) is focused on specialty drilling in the harsh environments of the North Atlantic and Arctic regions. NADL went public on January 29, 2014, at $9.25 per share and raised $125 million. The company is majority-owned by industry leader Seadrill Limited (SDRL).

NADL has an advanced fleet of nine high-end ruggedized harsh environment mobile drilling units and one additional rig that is currently under construction. The company operates its rigs under contract with tier-1 exploration and production (E&P) companies and currently has a $2.4 billion backlog. Its West Linus rig commenced drilling under contract with ConocoPhilips on May 25, 2014. Revenue growth will come from new rigs scheduled to become operational in 2014 and 2015, and through its strategic partnership with Russia’s Rosneft. NADL is a top-tier driller with an exceptional track record for operational uptime and quality, health, safety and environment (QHSE) and is a safe bet for companies looking for an exceptional low-risk partner for harsh environment E&P.

Solid 9% Dividend Yield

In Q1 2014, NADL increased its quarterly cash dividend by one cent to $0.24 per share ($0.96 annualized). With shares at $10.65 (as of 07/04/2014), NADL provides an industry-leading dividend yield of 9.01%. The company has 241.1 million shares outstanding and a market capitalization of $2.6 billion (2.8x book value).

Moreover, quarterly dividends have grown almost 7x in three years from $0.035 in Q2 2011 to $0.24 in Q1 2014 – so investors can expect sizable dividend growth as new rigs become operational.

Shares are up 18% over the past three months (well above the 12.4% average gain for its peer group) and have a Forward Price/Earnings ratio of 10.5 that is significantly below its peer average of 15.8 even though NADL’s dividend yield and net margin are above peer averages.


The company is followed by five analysts with a high 12-month price target of $11, a mean of $10.50 and a low of $8.50; four analysts currently have a Hold rating on the stock. Analysts are down on the stock on Q1 weakness after severe winter weather but are not looking ahead at significant growth prospects.

 


Deep Partnership with Russia’s Rosneft to Drive Growth

NADL, Seadrill and Rosneft signed an Investment and Cooperation Agreement for offshore and onshore drilling in Russian controlled regions. The partnership has a minimum term of
eight years. NADL will initially enter into long-term drilling contracts for up to nine offshore rigs with a total commitment of 35 rig years, acquire one of Rosneft’s existing onshore drilling operations with modern assets and an experienced employee base and open regional offices to support Russia operations. In exchange, Rosneft will take a substantial equity stake in NADL but Seadrill will continue to be the company’s largest shareholder.

Strong Contract Coverage with Top-Tier Clients

NADL has strong contract coverage with $2.4 billion in contracted backlog with A-rated customers such as ExxonMobil, ConocoPhilips and Statoil.


Its assets are 99% contracted for 2014, 76% contracted for 2015 and 51% contracted for 2016. The company’s premium harsh environment assets, high operational performance, excellent safety record and key client relationships with top-tier oil companies are solid prerequisites to securing new contracts.

 


 

Major Pipeline of Harsh Environment Projects Ensures Rig Demand

Further, with major harsh environment projects in the pipeline, NADL is virtually certain that its rigs will be fully utilized. Major harsh environment pipeline projects are in various stages of planning and development in Norway (Johan Sverdrup, Johan Castberg, Maria, Zidane, Luva, Snohvit, Bream fields and Barents Sea exploration), Russia/Arctic (Rosneft and Black Sea requirements), UK/West of Shetland (Laggan/Toremore, OMV, Nexen), Canada (Bay du Nord, Mizzen; and Exxon, Husky and Statoil indicating that 2-4 more units will be needed in the region longer term), Falklands (Sealion development) and Alaska.

The supply of rigs has increased at a 14% annual rate over the past five years to keep up with growing demand, and capacity utilization has rocketed from 40% in 2005 to 100% in 2013.

 


 

Significant Arctic Opportunity Will Also Drive NADL Contracts

The Arctic region is estimated to have over 400 billion barrels of oil equivalent, with 85% of this offshore and over 50% in regions controlled by Russia which could hold as much as 30% of global undiscovered natural gas and 13% of global undiscovered oil.

NADL’s strategic agreement with Rosneft is a real game changer because Russia’s offshore harsh environment areas contain about 5x the recoverable resources in Norway

 


Proven Operational Excellence Enhances Growth Prospects

NADL is recognized for the high quality of its operations in the most challenging sectors of offshore drilling. The company has over 1,600 skilled employees with over 40-years of harsh environment offshore drilling experience, and is known for its focus on procedures to control, measure and improve performance and risk management.

Customers also recognize NADL for high performance with stable and high average economic utilization (~95% over the past two years) and high reliability in challenging remote environments.


 

NADL has a strong focus on QHSE and one of the most stringent safety control systems in the drilling industry. Its fleet is 100% certified with the Norway’s Acknowledgement of Compliance (AoC), one of the toughest QHSE certifications in the industry.

Q1 2014 Highlights – Revenue Dip Reflects Seasonality; Revenues Set to Grow for Rest of the Year

For its Q1 ended March 31, 2014, NADL reported contract revenues of $226 million and total operating revenues of $274 million, with revenues impacted by an extraordinarily harsh 2013/2014 winter. As a result, net operating income dipped to $71 million, to its lowest over the recent four quarters – reflecting seasonal revenue dips in the winter.

The decline in revenue and income are due to normal business fluctuations and repair/maintenance related downtime. For example, the company’s West Alpha rig was down for scheduled component inspection and routine maintenance to ensure optimal functioning. Two of the company’s North Atlantic drill rigs were also impacted by equipment failures tied to extreme cold conditions and generated less revenue than normal. But with both rigs now functioning well, second quarter revenues should bounce back up. In Q1, NADL’s fleet had 10% downtime but only about 2% downtime in Q2. In addition, the new West Linus rig, which started operations in late-May 2014 at $375,000 per day, should boost results.

 


In Q1, NADL had EBITDA of $119.3 million, net income of $20.2 million and earnings per share of
$0.08. NADL generated $32 million in cash from operations. However, brighter prospects suggest full-year earnings could reach about $1.03 per share based on new rigs and favorable demand.

In the quarter, the company issued $600 million in senior unsecured notes due 2019 through a private offering in the U.S.

At quarter end, NADL had cash and cash equivalents of $114 million, $2.4 billion in drilling assets (net of depreciation), $715 million in new buildings and $4.1 billion in total assets.

With the recent $600 million private placement, debt was up from $1.58 billion in the previous quarter to $2.25 billion and shareholders equity rose to $936 million.

Summary

Analysts are down on the stock on Q1 weakness after severe winter weather but are not looking ahead at the significant growth prospects. The company’s premium harsh environment drill rigs, its outstanding QHSE record, strong Arctic E&P prospects and game-changing strategic partnership with Russia’s Rosneft and new rigs should power earnings and dividends going forward. This is an excellent company for stable dividend income investors who will see good dividend and capital growth over the long run.

This is a billionaire John Fredriksen creation. Mr. Fredriksen is known for creating companies heavy in debt and with significant dividend payouts.

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