Ocean Rig Still Undervalued With Upcoming Returns Of Capital To Shareholders

Executive summary:

• Ocean Rig has a giant backlog of $5.4 billion.


• It plans to reward shareholders with a dividend yield of 4%+.


• It's planning a conversion of certain assets to MLP.


• 2014 contracts are at 100%, 2015 contracts are at 72%.


• Recent new ship deliveries are powering growth.

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Early in 2014, I highlighted Ocean Rig (ORIG) as one of my top ten stock picks for the year. My three reasons were the conversion of a MLP and dividend initiation, deepwater pure play, and strong bookings. All three of those remain key reasons to buy the stock and after a recent fourth quarter earnings beat, investors should be ready to get behind this name.

In the fourth quarter, Ocean Rig reported earnings per share of $0.30. For the full year, adjusted earnings per share hit $0.94. The big news in the fourth quarter was the arrival of another ultra deepwater ship, the Ocean Rig Skyros. That ship will bring meaningful revenue to the company in the current first quarter, after being slightly delayed. In the first quarter, Ocean Rig will also take delivery of another ultra deepwater drillship. This new ship, the Ocean Rig Apollo, has a backlog of $757 million.

Ocean Rig continues to be a great play for at least the next three years, as day rates remain high and the company has a backlog ready to reward shareholders. The company is fully contracted for 2014 and has 72% of its days booked for 2015. In 2015, Ocean Rig has a backlog of $1.5 billion. Ocean Rig's 2016 backlog has $1.0 billion booked. In 2015, Ocean Rig will also take delivery of two more ultra deepwater drillships. The current total backlog for Ocean Rig is $5.4 billion.

The key reason to buy shares of Ocean Rig is its decision to focus on shareholders. From the earnings call, Ocean Rig wants to "focus on implementing our announced value creation initiatives for our shareholders". In May, Ocean Rig will pay out $25 million to shareholders in the forms of its first dividend. With 131.8 million shares out, Ocean Rig will be paying out a dividend of around $0.18. With current share price levels, the stock will yield north of 4% to investors. This should cause some investors and funds to start buying into Ocean Rig as a play on yield. With free cash flow increasing and earnings going north of $2.00 in 2015, the dividend should increase every year going forward.

The spin-off of assets into a MLP should unlock significant value for Ocean Rig and shareholders. While there are not a lot of details out, Ocean Rig will likely put some of its ships into the MLP. This should increase the value of Ocean Rig as a whole. Investors will be willing to pay more for the MLP and Ocean Rig will likely maintain a majority ownership of new conversion.

On the flip side, management did seem to be hesitant that the daily rates commanded for drillships now would continue for the long haul. The company believes it is in the middle of a bullish cycle that could see several contract renewals difficult. With new drillships coming into Ocean Rig's hands, I don't see this being a problem. An investment in a drillship can also be risky as the company counts on revenue every day from each ship. Possible downtime or delays in delivery, as seen with the recent new ship, hurts revenue and earnings.

Shares of Ocean Rig are down around 10% on the year. Shares now trade at 10 times expected 2014 earnings per share of $1.69. Going forward, shares trade at only 7.6 times expected earnings per share of $2.29 for fiscal 2015. With a coming dividend payment and spin-off of assets, this is a stock to consider for a great 2014 going forward.

Source: Ocean Rig Still Undervalued With Upcoming Returns Of Capital To Shareholders

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ORIG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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