Odfjell Drilling Ltd

OSE:ODL

Earnings Call Transcript 2019-Q1

[Operator]

Good day and welcome to the Odfjell Drilling Q1 2019 Investor Call. At this time, I would like to turn the conference over to Atle Sæbø. Please go ahead, sir.

[Atle Sæbø, CFO & Executive VP]

Thank you, and welcome to this Investor Conference Call for Odfjell Drilling where we will present the 2019 first quarter results. Together with me, I have Eirik Knudsen, Investor Relations Officer; and Simen Lieungh is joining by phone and will be available in the Q&A session after the presentation. If we go to Page 2, and we will today take you through the highlights and material events, the segment reporting, financial information before we end this call with a short summary and then open for a Q&A session. On Page 3, we have the key summary for the first quarter. And first, the refinancing commitments secured; we have delivery of Deepsea Nordkapp from shipyard and safe mobilization to Norway; successful operation in South Africa with Deepsea Stavanger; secured management on Deepsea Yantai; BP awarded platform drilling contract on the U.K. Continental Shelf; strong operational performance across the MODU fleet; continued strong performance in Drilling & Technology; and Well Services with continuous pressure on prices.Then we move over to Page 4, delivery of Deepsea Nordkapp from shipyard and commencement of contract. The Odfjell Drilling has, on the 7th of January 2019, taken delivery of Deepsea Nordkapp from Samsung. After successful transit, Deepsea Nordkapp arrived CCB shipyard outside Bergen, Norway in early April. The rig commenced a 2 years fixed contract with additional 2 x1 years options contract with Aker BP on the 10th of May.BP extended contract for platform drilling services on the U.K. Continental Shelf. On the January 29, we was awarded a contract for platform drilling and maintenance services on 3 of BP platforms in the U.K. North Sea as informed in the last quarter. Management agreement for Deepsea Yantai. Odfjell Drilling has secured a 4-year management agreement for Deepsea Yantai, formerly known as Beacon Atlantic. The agreement also secures Odfjell Drilling the exclusive right to purchase the unit and the right of first refusal on any offer to purchase the unit following the exclusivity period. The unit has received a 6-plus-10 wells drilling contract with Neptune on the Norwegian Continental Shelf, expected to commence end of 2019.Then we move over to Page 5, refinancing commitments. Odfjell Drilling has, on May 28, received firm bank commitments for a refinancing related to its 2019 debt maturities. The existing facility covering Deepsea Atlantic and Deepsea Stavanger, currently with USD 400 million outstanding, will be replaced by a new senior facility of USD 425 million. In addition, a junior facility of USD 100 million will be entered into. The senior facility will be repaid by quarterly installments of $12.5 million, first time 6 months after drawdown. The junior facility has no fixed installments, but shall, on certain conditions, be partly repaid annually from third quarter 2021 by free and available liquidity of the Odfjell Drilling Group above $175 million.Interest is payable at LIBOR plus an overall margin depending on the level of net debt to EBITDA for the Odfjell Drilling Group, resulting in an estimated combined average margin of around 400 basis points over LIBOR during the tenor of the facilities. The senior facility is available in 1 drawing after signing of the facility documentation and the junior facility is available in 3 drawings until end of March 2020. The tenor of both facilities is 5 years. The Services facility, currently with USD 250 million outstanding, will be amended and extended to November 2021. The facility will be divided in 2 tranches: tranche A of USD 150 million, which is non-amortizing; and tranche B of USD 100 million with semiannual installments of USD 20 million, first time in November. Interest is payable at LIBOR plus an average margin of 470 basis points. The commitments above are mutually dependent, and otherwise subject to final documentation and customary conditions precedent for drawdown.And then we move over to Page 6, the Mobile Offshore Drilling Units. We have continued our operational -- strong operational performance in the quarter and achieved an average financial uptime above 98% across the fleet. On next page, Page 7, I will take you through the contract status for each rig on the following slide. Deepsea Bergen operated for Equinor until 19th of March and mobilized to the U.K. Continental Shelf for 1-well drilling contract for Ithaca, which started 25th of March. Thereafter, the unit will return to Norway and commence 1-well contract for OMV late May, early June, followed by a 1-well contract with MOL. This will keep Deepsea Bergen in operation throughout 2019. Deepsea Atlantic commenced its current drilling contract under the master frame agreement with Equinor on 24th January after completion of the special periodic survey. Deepsea Stavanger successfully concluded its contract with Total on 12th of February and after a safe demobilization back to Norway, the unit commenced its 12 months contract with Aker BP under the alliance agreement on the 7th of April. Deepsea Aberdeen is contracted until April 2022 for BP West of Shetland. The newbuild Deepsea Nordkapp was delivered from Samsung the 7th of January 2019. The unit arrived Norway in early April and successfully commenced its first well with -- under the contract with Aker BP on the 10th of May. Finally, our last addition to the fleet, Deepsea Yantai, is scheduled to be delivered from the yard in June, July and expected to commence its contract with Neptune before year-end. The firm MODU contract backlog is $1 billion at the end of March '19, with additional priced options for USD 200 million. Then we move over to Page 8, the Platform Drilling & Technology. And platform drilling is secured by medium- to long-term operations on the U.K. and Norwegian Continental Shelf for BP, TAQA, Serica Energy, Equinor and Wintershall. We started operations on the Johan Sverdrup field in fourth quarter last year and estimate to commence operation on the Mariner field in third quarter this year. The new BP contract also commenced end of January this year, taking firm operation for BP into beginning of 2021. We are very pleased our platform drilling continues to provide safe and efficient drilling services to our clients combined with healthy financial performance. Platform drilling operations are secured by medium- to long-term contracts with a contract backlog of $1.1 billion, where USD 800 million is priced options. And we move over to Page 9, Well Services. Well Services is operating in around 20 countries worldwide, including North Sea market, Mainland Europe, Middle East and Southeast Asia. The product portfolio includes tubular running services, rental services and well intervention services. The rental service line is still representing a relative small share of Well Services revenue. However, the market outlook is promising for this service area. Then we move over to Page 10, the backlog. At end of March, as mentioned, the order backlog was USD 2.3 billion, where USD 1.3 billion is firm contracts. Revenue from frame agreements and call-off contracts in Well Services and revenue from technology and MODU management is not included in the backlog.Then we move over to Page 11, market outlook. Following the drop in oil prices in 2014, the drilling and oil service market has suffered a severe decrease in the total activity level. Downturn has resulted in major impairments across the sector and oil companies has been forced to reduce cost and establish more efficient operations. The efficiency programs carried out by the oil companies have led to substantial reduction in field development and production spending. The global drilling and oil service market is currently growing at a steady pace, however, with some regional differences. In harsh environments, we have observed a higher demand combined with a substantial number of mature units permanently withdrawn from the market. This has led to an increased utilization of the harsh environment fleet. Based on the preference of new and more efficient units, combined with a high reactivation cost, we believe the scrapping of all the mid-water and harsh-environment drilling units will continue over the next few years. In combination with a more healthy market environment, we believe this trend will bring the harsh environment market back into balance with improved day rates.Well Services is still facing fierce competition for its services globally. We currently observe an increased tender activity in the European and Middle East markets. However, the oversupply of equipment will, in the short to medium term, continue to keep pressure on prices. The slowdown in the North Sea market has led to a low activity level for development and upgrade projects over the last few years. Drilling & Technology has experienced an increase in demand for its services and is well positioned to take part in the market recovery. Then let's move over to the financial section and we go to Page 13, which is the group summary financials. The group operating revenue was USD 201 million compared to USD 175 million in same quarter 2018. Operating revenue increased mainly due to increased revenue in MODU segment from Q1 '18 to Q1 '19. The group EBITDA was $73 million compared to $56 million in first quarter 2018. The EBITDA margin has increased to 36% compared to 32% same quarter in 2018.Depreciation was $42 million compared to $40 million in '18. The net financial expenses were $20 million compared to $23 million in the same quarter last year. This quarter, the tax expense was $1 million. Profit for the period was $10 million compared to a loss of $7 million in first quarter of '18. This was the blended figures for the capital-intensive MODU segment and the labor-intensive Platform Drilling & Technology segments. We will now look into each of these segments and start with the MODU on next page. Operating revenue for the MODU segment was $152 million compared to $119 million in the same quarter 2018. The increase in revenue is mainly explained by an increase in revenue for Deepsea Stavanger as the major share of revenue from the Total Brulpadda project was recognized in first quarter 2019. This was partly offset by a decrease in revenue for Deepsea Atlantic as the special periodic survey was completed in January. EBITDA was $67 million compared to $53 million in '18. The change in EBITDA is mainly due to the incentive which was achieved for the Total Brulpadda project. EBITDA margin was 44% compared to same level in the same quarter last year. Depreciation was $34 million in the first quarter compared to $33 million in the same period last year, ending with an EBIT of $33 million compared to $20 million in Q1 2018. We then move over to Page 15 to Drilling & Technology financials. Operating revenue was $34 million, that's the same level as in the first quarter of '18. EBITDA was $2 million compared to $1 million in the first quarter '18. The increase in the first quarter in EBITDA is mainly due to more profitable projects within the engineering activities. The EBITDA margin was 6% compared to 2% in the first quarter '18. Then we move over to the Well Services on Page 16. Operating revenue was $25 million compared to $28 million in first quarter '18. The decrease in revenue for OWS segment in first quarter '19 is explained by lower activity levers in the Norwegian markets, partly offset by higher activity in Middle East, Africa and Asia. EBITDA was $5 million compared to $6 million in the same period last year. The EBITDA margin dropped from 23% in '18 to 19% in the first quarter of '19.On Page 17, we have included the group eliminations and reconciliations for your information. Then we go over to Page 18, which is a summary statement of financial position. And at the end of first quarter, the group's gross interest-bearing debt was $1.442 billion is net of capitalized financing fees. We had $191 million in cash and an equity ratio of 39% at the end of first quarter 2019.Then we move over to Page 19, the summary statement of cash flow. And in this quarter, net cash from operations was $36 million, net cash from investing activity was negative with $311 million. This is mainly related to the delivery of Deepsea Nordkapp. Net cash from financing activities was positive with USD 294 million, and that is again related to drawdown of the financing of the Deepsea Nordkapp bank facility at delivery. Cash and cash equivalents is USD 191 million at the end of first quarter compared to USD 194 million at the same period last year. Then we move over to Page 20, which is the summary for the first quarter 2019, and we start with the mobile drilling units. Here, the fleet is secured by medium- to long-term contracts. We have continued the strong operational performance and financial utilization of the fleet. Delivery and successful mobilization of Deepsea Nordkapp in the first quarter. And the market is improving and we observe an increasing demand for the ODL fleet, which we will benefit from through alliance and master frame agreements with yearly rate adjustments.Drilling & Technology, continued strong financial performance; the platform portfolio secured with medium- to long-term contracts; more work secured for BP on the U.K. Continental Shelf and mobilization of Mariner, which will happen in the third quarter this year.Well Services; here, we can see an increased tender activity in the European and Middle East markets. However, the oversupply of equipment is keeping prices at low levels, but the turning point has passed. If we then go to the key financials, we have an earnings visibility through $2.3 billion order backlog. We have a book equity ratio of 38% and cash position of $191 million at the end of March '19. And we have secured a USD 775 million refinancing commitments recently. This concludes our presentation, and we will now open for Q&A session. So please, everybody, if you have question, comments?

[Operator]

[Operator Instructions] And we will take our first question from Jamie McFarlane from Bybrook Capital.

[Jamie McFarlane]

Congratulations on a good quarter. I just wondered if you could provide a little more clarity on the expected timing and the expected potential rate on the Aker BP call-off. And then just across the rest of the fleet, what's the milestones you're looking at on the MODU fleet for the rest of the year are in terms of new contracts and contracts out there that you'd like to look at winning?

[Simen Lieungh, CEO & President]

Simen here. Thank you. Well, I cannot be very detailed about the specific contracts, but we are, naturally, during the last period, we are, of course, discussing with our client, like Aker BP you mentioned, also with Equinor, the master frame agreement and other contracts. So we are engaged in discussions to prolong and extend the activity and engagement of the assets. Especially with Stavanger and Atlantic, we expect that the rate will increase. From the current $300,000 level, we expect somewhat increase going forward. There will be a combination, of course, by incentives and the day rate. Again, I can confirm there will be increases, but how much and to what extent, we need to come back to. But there are quite heavy activity we expect now going forward to conclude all these matters, and I hope to conclude not too far into the future. Is that okay answer or did you have more?

[Jamie McFarlane]

No, that's very helpful.

[Operator]

[Operator Instructions] We'll take our next question from Lukas Daul with ABG.

[Lukas Daul, Analyst]

Atle, I was wondering, in connection with refinancing, I guess you're going to sort of expense some debt fees or something in the second quarter or when that takes place. Do you have a ballpark figure for what that's going to be?

[Atle Sæbø, CFO & Executive VP]

No, I don't have the fee structure in my mind, what that exact amount will be, but, of course, is a limited amount.

[Lukas Daul, Analyst]

Okay. Well, I can take it off-line afterwards. And then on the availability, Simen, I mean you did a well in South Africa and now Total is looking at drilling a bit more there, but your fleet is pretty much booked. So I was wondering if you sort of could provide some color on how you're thinking about providing that capacity for clients that might be interested in using your rigs?

[Simen Lieungh, CEO & President]

Yes. Again, can't be too specific here, but we are engaged with Total to discuss potential capacity for the next campaign. We can say the first campaign was done successfully. South Africa, just to say it, is a quite demanding area. We spent some 2, 2.5, 3 years with Total to qualify our Deepsea Stavanger, and there are not too many other assets available really of that kind that could do that work within a relatively short notice. So if they're going to do the campaign in 24 appraisals, we are discussing with them how we could support them to do that. Of course, the DVA concept we have with the facilities are quite attractive. But I should say we are occupied by -- the rigs are occupied, but we are -- we do have 3 DVA concepts in the fleet and we are talking to Total and other clients to see what could be done to let capacity flow down to South Africa. We need to come back to that. And again, I don't think we will spend too much time into the future to make a decision, either yes or no. But when we are -- has concluded or not concluded, we will inform the market.

[Operator]

And we will take our next question from Antoine Coutand with Kite Lake Capital.

[Antoine Coutand]

I was wondering, can you comment on the maturity and the strike price of the purchase option you have on the Beacon Atlantic?

[Simen Lieungh, CEO & President]

I think the Beacon Atlantic, which is now renamed to Deepsea Yantai, we do have an option to buy the asset, but we are quite clear that we won't kind of do it bluntly by raising equity and borrow money. We haven't agreed. I mean we don't have a fixed price or anything else there. We do have a contract now where -- which is going to last some time and we are looking for -- or start again. The way we did this management setup is, of course, with an ambition to actually take over the asset. The way we're going to do that must be -- will be on a value creation basis, more like on relative values. So in the current markets, they were the implied values on the rig compared to the fair market values out there and maybe some expectations about the pricing. It's not really coordinated, if you understand what I'm meaning. So we are discussing how to do this, but I can say we will exclude the route we're running with the equity and some bank or bond financing on top. So you have to give us time to conclude on this one, but the ambition is clearly to get at the ownership of that rig because we see that rig as quite interesting for the expansion of the fleet. But the way we're going to do it will be carefully discussed and negotiated, and hopefully, we will some time down the road conclude how we'll do that.

[Antoine Coutand]

Sure. Does that mean that you did not reach an agreement with the yard at the moment, that you are basically trying to negotiate with them currently?

[Simen Lieungh, CEO & President]

We are to say that way. We are talking about how to do this and that was also the full plan because we have to act to provide the capacity for Neptune. So we haven't deliberately kind of agreed on a certain route. We have certain options that we should continue to talk about because we do have a couple of years ahead of us to agree on these things, and so I leave it there.

[Antoine Coutand]

Great. Okay. But there's no maturity, explicit maturity for the option?

[Simen Lieungh, CEO & President]

That need to be negotiated. Nothing today, okay?

[Antoine Coutand]

Sure. And maybe just one last question. Maybe the excess liquidity that you would have with the recent bank financing could be used for a first paydown on this unit, you think, or....

[Simen Lieungh, CEO & President]

As I said, I don't think you should speculate on that too much. We have created -- the refinancing package was successfully concluded yesterday. So we have created some flexibility for us to look at certain options going forward. We have not earmarked anything for anything. So as I said, I don't think you should expect us to just to buy -- kind of pay down the rig like we did some years ago. Like, for example, we did the Nordkapp. That's not going to happen. So it's going to be a different structure on this potential acquisition. Maybe a combination of fair market values, relative values, shares and so forth. We have also announced that we are looking at the structure of the total company, so this is in total combination. We are currently trying to find a smart way and a value creation way to do this potential acquisition. But the flexibility with the financial setup we do have today has just created flexibility for us to act on certain potential things coming ahead -- coming against us. That's why we have not earmarked anything for any special cases. Okay?

[Antoine Coutand]

Sure.

[Operator]

And we will take our next question from Lillian Starke with Morgan Stanley.

[Lillian Starke, Research Associate]

I was just wondering if you could give a bit more color on sort of the opportunities that you're seeing and, clearly, the Deepsea Yantai was a good option to take on, but I'm not sure if there's any other options like this one that you see lying around in any of the shipyards or that sort of have caught your eye that we could be thinking about.

[Simen Lieungh, CEO & President]

Well, I think it's -- the current market is really -- is not allowing or is not just -- kind of justifying any newbuild. So there are -- and there are limited numbers of newbuilds within the harsh environment we're looking for. We have -- our focus going forward in Odfjell Drilling will be very much to the harsh environment market. We have said that we need more capacity and we will be hardworking to get that capacity available. Yantai is one step in that direction and we do that to also to fulfill our commitments against our clients because we do have more demand than we can supply for the time being. So there are other assets down there. For example, a couple of others in China that could be of interest to us. But, again, it has to do with the engagement concept-like contract, it has to do with the discussions on type of how do we access the assets. So the good thing I can tell you that we are in a very good and close dialogue by spending 2 years to get hold of Deepsea Yantai. We are -- we have finally kind of broken through the ownership of the assets down in China. We know that there is a lot of activity around there and lots of rumors going around there, but we do have quite good, I will say, information and access to discuss these assets. And I think that when we are taking the Deepsea Yantai to operation, we will prove that these assets are quite okay actually. And by that, we will also try to, if necessary and if the demand is there, to try to get hold of more. There are 2 more down there in the same type of concept that could do the -- that could service our needs, but we're not there yet to conclude on anything.

[Lillian Starke, Research Associate]

Okay. And just in terms of the negotiation, you mentioned it took you 2 years to take ownership of the Yantai. What are sort of the bottlenecks or the issues that you see where negotiations are tighter? Is it more on the deliveries hit more on price? Just to get a bit of -- a bit more color on sort of where these negotiations may be taking a bit more time.

[Simen Lieungh, CEO & President]

Well, we have spent so much time to get where we are. We don't foresee that. We've been close to the timing if we take the next step. But I think the cocktail you talk about that has taken some times, there has been a little bit of everything. Lots of interest, lots of people running around, lot of brokers, lot of drill contractors. Of course, price is important. And within -- with this market, there are a lot of speculation on everything. And I'll say the "poor" Chinese has been kind of bombed by different interests and to find the right partner to work with took some time, and we don't foresee that will happen again. So we are there now. So we might move, if the case appears, we might move much quicker next time.

[Operator]

And our next question comes from [ Ben Graham ].

[Unknown Analyst]

I have 2 questions, and the first one relates to the day rates in Norway. We know that base day rates are around $300,000 per day, but what is the incentive and bonuses as a percentage, in general?

[Simen Lieungh, CEO & President]

As you say, the day rates are about $300,000, which is the perfect rate, and we are now moving into the campaigns with our alliance partner and frame agreements partners, which both of them, like Equinor and Aker BP, has bonus schemes, incentive schemes on top. This is quite new really, and none of those schemes have really been tested over some time. But I can say that I think -- I will say maybe a little conservative thumb rule, you can kind of talk about the 10% average on top of the day rate typically. Sometimes more, sometimes maybe much more and sometimes less and hopefully not too much less.

[Unknown Analyst]

Okay. And my second question regarding the future. Because if one looks at your fleet summary, you have booked capacity until late 2022 mostly. Are you approached by some oil majors who want to discuss projects in the future or you're not engaged in that kind of private conversations yet?

[Simen Lieungh, CEO & President]

Did you say oil majors or with oil companies or...

[Unknown Analyst]

Oil companies, yes.

[Simen Lieungh, CEO & President]

Oil companies. Yes, yes, yes, sure. We are certainly looking and talking about the time beyond the '22 -- '21, '22. And I think that it's fair to say that within the -- I think also within the -- actually outer deep market, in '22, '23, in that range, plus we see the market, in general, will be much better and there are some prospects out there that could be of interest, which could justify longer contract. Day rates, I won't speculate in, but better than today, of course. And so there are some handful of projects that we see now within the harsh environment area that could be of interest, which has longer horizon than just some well programs and so forth. Could be term contracts; could be 2, 3, 4 years; and there's a handful of them approaching. But again, it's far ahead from us and there will be -- clients has a tendency now to look at the efficiency which has been gained over the last 2, 2.5, 3 years and everybody wants to, of course, engage with companies that can support that efficiency program. So there is a little shift in that market to look at what kind of assets, what kind of players do they want to engage to achieve those benefits. So there are more activity coming for sure.

[Unknown Analyst]

And I have one last question, if I may. And that is the cost savings you have found in this downturn, are they permanently or do you see some kind of cost escalation at your side of the market yet, personnel and equipment and so on?

[Simen Lieungh, CEO & President]

Well, I think that it's not possible to avoid cost increases going forward. The key now is how do we compensate for those things, like salary increases, like suppliers want to sell their equipment more expensively and we, of course, see that. When the market comes up, history will repeat over and over again. So the key now is to try to do all your efforts to keep the control of the cost level to keep it in pace with, I'll say, the moderate increase of the rate level going forward. So your point is very valid. It's extremely important to be creative to keep your costs down and do things more efficiently and reduce OpEx and all the fancy things. During the downturn, we have done a lot to reduce the cost level and that has been significantly reduced. The key now is to maintain all those activities in different formats to try to keep control of that level, not to just explode in the future. If you listen to oil companies, if you listen to our competition, we all talk about the same. But are we able to execute on those ambitions, that remains to be seen, and I can't guarantee you that, that will happen. But I can tell that we will do our utmost to try to keep our costs down and do things more efficiently and a different way and make sure that we kind of have relatively good control of the cost increases. This is just gravity in our works and sometimes it's difficult to avoid gravity.

[Operator]

[Operator Instructions] We will take our next question from Frederik Lunde with Carnegie.

[Chr. Frederik H. Lunde]

I'm just looking at the sort of return on capital in the company historically and looking forward and cost of debt now around 6%, 6.5%. Just curious how you're thinking about employing capital on new projects. And I realize this is a cyclical industry, things are improving, but how do you think of the return requirements for new investments?

[Atle Sæbø, CFO & Executive VP]

Well, first of all, we are looking at new projects at return of equity. And this is, of course, depending on the pricing of third-party financing, the duration of the contracts, et cetera. But we have in the history and also now looking at to enter into new project, you should see a return on equity in that project somewhere in the area of 12% to 15%. That's what we have based our recent acquisitions on of units, but, of course, sometimes you have to -- if you could have a very low risk on a project, you could go somewhat below that. But 12% to 15% return on equity. We are not basing our project on the return of the total capital employed. We're also taking into combination the contract that is behind that asset.

[Chr. Frederik H. Lunde]

And you see that kind of return on the potential investments now or do you expect the [ assets of prices ] to sort of adjust or day rates to increase meaningfully to get to that range?

[Atle Sæbø, CFO & Executive VP]

Well, you don't see that level of return on any newbuilds or on any purchase in today's markets. There's still a gap. That's why also Simen said that we are not out in the market now for acquiring new units and paying with cash or going to the equity market. Now we have to use other instruments that could be a relative valuation for units, payments in shares, it could be other solutions, but we are not there today to put new money on the table to get hold of units.

[Operator]

And it appears there are no further questions in the queue at this time. Atle, I would like to turn things back to you for any additional remarks.

[Atle Sæbø, CFO & Executive VP]

Okay, thank you. If there are no more questions, we will thank you all for the attention to this first quarter presentation. Thank you.

[Operator]

And this does conclude today's call. Thank you for your participation. You may now disconnect.