Aban Offshore: Buy


Spurt in global exploration activities on the back of a steadily rising oil price scenario suggest good prospects for Aban.




Tight supply of rigs worldwide may help Aban scale up revenues

Given the large fleet size and presence in global markets through its foreign subsidiaries, Aban could emerge as one of the leading beneficiaries of this demand uptrend.

Aban's well-timed fleet expansion moves are backed by good operating efficiency and re-pricing of old contracts at higher rates. At the current market price of Rs 3,887, the stock trades at 11 times its likely FY-09 per share earnings.

This appears reasonable considering Aban's historical earnings growth and the ongoing cyclical uptrend in the offshore drilling industry. Investors can utilise the recent correction in the stock market to accumulate the stock.

Expansion in fleet size

Aban's strategy of expanding its fleet size has helped given the rising demand for rigs on the back of a relative stagnation in availability. After the acquisition of Norway-based Sinvest ASA, Aban's fleet size has increased to over twenty offshore assets, which includes 15 jack-up offshore drilling rigs, two drill ships, one floating production platform and a jack-up and drill ship each on bareboat charter. This fleet size is huge vis-À-vis other domestic players and compares well with some of the bigger global players as well.

Equipped with such a large rig bank, we expect Aban to enjoy a fast track growth in revenues, given the tight supply of rigs worldwide.

This apart, the proposed addition of a few more rigs to the company's fleet in a couple of years may also lower the average age of its fleet considerably. This is likely to improve the marketability of Aban's rigs, even as day rates might begin to taper-off by 2010. Further, Aban also stands to benefit by way of expansion in margins given the relatively lower refurbishment cost of new rigs.

Strengthening day rates

With a dearth in availability of oil rigs, day rates over the past couple of years have soared significantly. In this context, the re-pricing of most of the existing contracts of Aban Offshore (the standalone entity) at attractive prices lends confidence on the demand scenario. It also provides earnings visibility for Aban over the medium-term since most of these contracts have been committed for a medium-term horizon.

The most recent renewal of its three-year contract for Frontier Ice with ONGC at a day rate of about Rs 62 lakh (a significant premium to market expectations) reiterates the strong demand prospects.

Notably, this contract also (previously Aban II and Aban VI) has been billed in non-USD currency. This might offer some respite to Aban's earnings from any likely depreciation in the US currency.

Financials

On a standalone basis, the company clocked an earnings growth of over 130 per cent for the quarter ended December 2007. This was achieved on the back of a 34 per cent increase in revenues, thanks to the re-pricing of two of its assets during the quarter.

Operating profit margin was marginally lower at about 53.08 per cent. The company, however, has a high gearing, given the aggressive capex incurred for the construction of new assets and the funding of its Sinvest acquisition. While this could weigh on Aban's earnings over the medium-term, it may begin to ease-off once the new assets become operational. Till such time, Aban's cash flows may help it service its debt efficiently.

Near-term triggers

The company is expected to announce the contract for its newly built jack-up Aban VIII in the next couple of months. This, if struck at higher than expected rates, may offer a short-term upside trigger.

Besides, the proposed listing of its Singapore subsidiary, aimed at refinancing its existing debt structure, may also provide an earnings upside.

While the company expects to retire a chunk of its debt through the potential listing, a lot might hinge on the revival of the IPO market and the perceived valuation of the subsidiary. That apart, a fall in oil prices and excess supply of oil rigs, resulting in a lower day rates, may pose a downside risk to our recommendation.