Aban Offshore : Book Profit, Current market price: Rs1,086

Key points

• ERHC Energy Inc (ERHC) has informed that the contract for Aban Abraham, the deepwater oil rig of Aban Offshore, with Addax has been cancelled. The rig was contracted for a period of 14 months with an option for a six-month extension. The contract was slated to start from May 2010 at a day rate of $410,000, after the expiry of the oil rig?s existing one-year contract with Kosmos Energy. 

• Aban Offshore has not signed any new contract in the last seven months, raising serious concerns over its future and its ability to service its high debt. Currently, it is actively marketing seven of its idle rigs. At such a time, the cancellation of the contract for Aban Abraham has come as a big blow to the company. However, the outlook for the deepwater segment is much better in comparison with jack-ups and the company should be in a better position to secure a new contract for Aban Abraham as compared with its other jack-up rigs. 

• The outlook for the jack-up rigs remains tight in view of the 69 new additions, out of which only 23% are backed by firm orders. With the demand unable to absorb the incremental supply, the softening of the day rates might continue as the utilisation levels fall going forward. This would be a negative for Aban Offshore as it is predominantly present in the jack-up segment. 

• The highly leveraged position of the company remains one of the biggest concerns with its $3.2-billion debt. Looking at the amount repayable in the next couple of years and its expected cash flows, Aban Offshore is unlikely to meet its debt repayment schedule. However, it has been in talks with bankers for restructuring its debt and some payments to banks have been rolled over due to its inability to repay debt at present. 

• Though any progress regarding the debt restructuring would come as a positive for the company, we believe that the company would have limited options at this point and would have to surely raise equity as parts of its debt restructuring exercise. However, in view of the current environment, the lower than expected cash flows from its operations and its high debt, we believe that the equity dilution could be significant, to the tune of almost 30-40%. After factoring in that the valuation of the stock looks steep at the current market price.

• We are reducing our FY2010 and FY2011 estimates by 13.7% and 31.2% respectively, factoring in the change in our dollar assumption, the delay in the deployment of Aban Pearl and the cancellation of Aban Abraham?s contract. At the current market price, the stock is quoting at 5.8x its FY2011E earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 6.7x. Though the valuations are lower than those of its global peers on price-earnings basis, its at a 28% premium on EV/EBIDTA basis, which doesn?t seem to be justified considering its highly leveraged balance sheet and the idle status of its rigs. The current stock price is also much above our discounted cash flows (DCF) based fair value of Rs708 for the stock. In view of the multiple concerns, we are advising investors to book profit.