Here Are Smart Money’s Favorite Offshore Drilling Bets

Although most offshore drillers aren’t profitable at current crude prices and some have large debt loads, the sector does have potential for big gains if crude prices continue to rally. In this article, we take a look at some of the smart money’s favorite offshore drilling plays, including Seadrill Ltd (NYSE:SDRL), Transocean LTD (NYSE:RIG), Atwood Oceanics, Inc. (NYSE:ATW), Diamond Offshore Drilling Inc (NYSE:DO), and ENSCO PLC (NYSE:ESV).

Through extensive research, we determined that imitating some of the picks of hedge funds and other institutional investors can help generate market-beating returns over the long run. The key is to focus on the small-cap picks of these investors, since they are usually less followed by the broader market and are less price-efficient. Our backtests that covered the period between 1999 and 2012, showed that following the 15 most popular small-caps among hedge funds can help a retail investor beat the market by an average of 95 basis points per month (see the details here).

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#5 Atwood Oceanics, Inc. (NYSE:ATW)

– Number of Hedge Fund Holders (as of March 31): 18
– Total Value of Hedge Fund Holdings (as of March 31): $72.22 million
– Hedge Fund Holdings as Percentage of Float (as of March 31): 12.20%

A total of 18 funds from our database were long Atwood Oceanics, Inc. (NYSE:ATW) at the end of March, unchanged from the previous quarter. Atwood reported terrific first-quarter results, with EPS of $1.89 on revenue of $296.4 million, beating estimates by $0.33 per share and $3.5 million, respectively. The company’s ultra-deepwater drilling costs fell by 20.6% year-over-year while Atwood’s deepwater costs fell nearly twice as much, declining 40.6% year-over-year. Atwood also reduced some of its debt in the quarter by repurchasing the principal of some senior notes that traded at a discount to their initial values. Shares of the company are up by 21% year-to-date and have more upside if crude prices rally closer to $60 per barrel and higher.

#4 Seadrill Ltd (NYSE:SDRL)

– Number of Hedge Fund Holders (as of March 31): 22
– Total Value of Hedge Fund Holdings (as of March 31): $110.83 million
– Hedge Fund Holdings as Percentage of Float (as of March 31): 6.80%

It seems that every time Seadrill shares rally, management does a debt-for-equity swap that knocks the price back down again. Seadrill’s management most recently issued 7.5 million common shares in exchange for the extinguishment of $50 million of debt principal. Subsequently, the company’s shares retreated from the around $4-per-share level to the $3.30 area. The $50 million debt deal follows a similar $55 million debt swap in May. Although the debt-to-equity conversions are painful, they give Seadrill more runway to wait for crude prices to rise past $60 per barrel and for offshore demand to turn around. The number of funds from our database with holdings in Seadrill Ltd (NYSE:SDRL) rose by one quarter-over-quarter to 22 at the end of March.

#3 ENSCO PLC (NYSE:ESV)

– Number of Hedge Fund Holders (as of March 31): 29
– Total Value of Hedge Fund Holdings (as of March 31): $275.81 million
– Hedge Fund Holdings as Percentage of Float (as of March 31): 11.30%

Analysts are pretty divided on ENSCO. Of the 27 analysts covering the stock, seven have ‘Sell’ ratings, fifteen have ‘Hold’ ratings, and five have ‘Buy’ ratings. Analysts at Bank of America recently initiated coverage on the stock, rating the stock ‘Underperform’, but assigning Ensco a price target of $10.53 per share, or roughly 2% higher than the market price at Friday’s close. Hedge funds are less divided. 29 elite funds were long ENSCO PLC (NYSE:ESV) at the end of the first quarter, up 6 from the previous quarter.

#2 Diamond Offshore Drilling Inc (NYSE:DO)

– Number of Hedge Fund Holders (as of March 31): 32
– Total Value of Hedge Fund Holdings (as of March 31): $207.3 million
– Hedge Fund Holdings as Percentage of Float (as of March 31): 7.00%

With a debt-to-equity ratio of 0.47, Diamond Offshore Drilling Inc (NYSE:DO) is one of the least levered companies in the sector. Although its shares won’t likely rally as much if crude prices spike, Diamond Offshore’s stock isn’t as risky as the more levered names either. The lower risk and the exposure to a potential crude rebound made the stock a fit for 32 funds tracked by us at the end of the first quarter, up by 10 from the previous quarter. Analysts see better times ahead, with an expected next-year EPS of $0.93, versus the company’s trailing twelve month EPS of $0.50.

#1 Transocean LTD (NYSE:RIG)

– Number of Hedge Fund Holders (as of March 31): 39
– Total Value of Hedge Fund Holdings (as of March 31): $597.67 million
– Hedge Fund Holdings as Percentage of Float (as of March 31): 18.00%

With 39 funds from our database holding shares in the company at the end of March, Transocean LTD (NYSE:RIG) is the smart money’s favorite stock in this list. Due to the crude crash, shares of Transocean have been beaten up and now trade at just 0.28-times book value. If Brent prices continue to rally higher, the demand for offshore rigs will increase, and the market value of those rigs will rise. As the market value of the rigs rise, Transocean’s price-to-book ratio will likely increase too. Although shares of Transocean have lagged its peers year-to-date, they could potentially do better once the stock rises above the 200-day simple moving average (SMA).

Disclosure: none