Research firm Credit Suisse has recommended neutral rating on Aban Offshore with target price of Rs 2820. Research firm believes that the current market price fully values the
expected increase in revenue from new jackups and new contracts at today’s rates.

Event:

We are initiating coverage of Aban Offshore with a NEUTRAL rating and a Rs 2,820 target price. After the acquisition of Sinvest, the share price of Aban Offshore has more than tripled. Risks are high and we shall closely watch near-term developments for comfort on debt servicing and contract rates.

View:

We believe that jackup day rates have little upside going forward. This is based on: 1) our forecast of range-bound crude prices (which have helped day rates in the past), 2) the increasing supply of jackups, 3) the comfortable demand-supply scenario for jackups in the near term and 4) forward rate expectations having turned. The acquisition of Sinvest last year has left the company focused on shallow water drilling prospects and with a large debt. Several jackups are still under construction and old contracts are to be renegotiated. With the rate environment remaining high, control on operating costs is important.

Catalyst:

The company needs to place new jackups and renegotiate old contracts over the next few quarters. The rates negotiated will affect the profitability implications, and deviations from expectations may affect the stock. Clarity on depreciation and tax rates in the overseas subsidiaries will increase visibility of future earnings. Publication of the first consolidated results should help.

Valuation:

We believe that the current market price fully values the expected increase in revenue from new jackups and new contracts at today’s rates. We value the company at 7.5x FY10E earnings, which is when all jackups are likely to be operational.

Limited value without rate upside

We initiate coverage on Aban Offshore with a NEUTRAL rating and a target price of Rs 2,820. We believe that jackup day rates, the principal profit driver for Aban, are unlikely to increase substantially from here on. The acquisition of Sinvest creates opportunities and risks associated with the large debt. While we think that rates will hold and allow Aban to enter into longer-term contracts and secure debt repayment, the sensitivities to rate turns until that happens are high. The next few contract negotiations are critical. We believe that the market price accounts for current day rates, new rigs and repricing of old contracts. Upside to the stock is likely to now come from contracts being signed at higher-than expected rates.

Limited upside to jackup day rates

We believe there is limited upside to offshore rig day rates from here. Rig rates have increased significantly over the last two years and are at historical highs. The supply of jackup rigs is also expected to come through, while global demand for shallow water jackups is expected to remain strong in the medium term. In India, incremental shallow water exploration acreage is limited, so the focus is on deep water exploration. There are signs that the market is easing off, with an increasing number of shorter-term contracts and the premium on longer-term contracts turning negative. While we believe that rates will remain strong and will provide Aban the opportunity to price new rigs and re-price existing rigs at higher levels, there is unlikely to be any significant upside to rig rates going forward.

Sinvest acquisition creates unique challenges

The recent acquisition of Sinvest creates risks in Aban that are different from other offshore drilling companies. The large amount of debt taken to finance the acquisition increases leverage and absorbs cash flow in repayment. Five of the acquired jackups are under construction and have not been contracted as yet. This leaves the company open to rate risk as and when these rigs enter the market. While revenue from the rigs is relatively easy to estimate, operating costs after the increased fleet size are not. With a larger fleet, the need to operate beyond India in a tight global environment while keeping costs under control will be important for the company going forward.

Share price fully values up-tick in revenues

Our target price of Rs 2,820 is based on 7.5x FY10E EPS. We believe that this fully prices in the increase in revenue expected from the additional rigs and the re-pricing of old rigs. Our valuation implies 9x P/E for FY10E earnings, in line with its global peers and an EV/EBITDA of 6x for FY10 EBITDA, again in line with its peers. With the current share price fully valuing current and future revenue, and relatively high business risk, we initiate coverage of the stock with a NEUTRAL rating and a target price of Rs 2,820.