The Hindu Business Line : Aban Loyd Chiles Offshore: Buy

The stock of Aban Loyd Chiles has the potential to appreciate beyond the recent run-up. At Rs 1,230, it trades at 20 times the expected FY-06 per share earnings. Our positive view is backed by the following facts:

A spurt in global exploration activity and, hence, a pick-up in demand for drilling services.

The addition of `Aban Abraham', a new drill ship acquired by its subsidiary, and chartered at a higher rate.

ONGC recently revising its contract for Aban II at roughly three times its earlier charter rate.

A majority of its contracts coming up for renewal in 2007 could get renegotiated at higher rates.

The company's strategy to finance its acquisitions through debt and FCCBs could minimise equity dilution and increase return on equity.

Exploration on a high

Globally, soaring oil prices have led to a heightened exploration activity. After a long lull, oil companies the world over are investing in exploration, leading to a sudden spurt in the demand for drilling services. Big investments are being planned and this could keep the demand going for the next few years.

Aban Loyd Chiles charters out rigs used in oil exploration. Five of Aban's rigs are on charter with ONGC. The latter plans to invest close to Rs 15,000 crore over the next few years in exploration, throwing up immense opportunities for Aban. Aban's experience with international players could prove useful in capturing opportunities in West Asia where current charter rates are higher than the rest of the world.

On acquisition spree

The company has been on an acquisition spree over the last two years. Its fleet has expanded from just three rigs in FY-04 to six jack-up rigs and two drill ships by 2006.

Another jack-up rig is under construction and will be added to the fleet by March 2008. The latest addition, `Aban Abraham', has been chartered this quarter and could bolster revenues starting from the January-March quarter of 2006. The fleet acquisition strategy is paying off well in a market where rigs are scarce and rates high. Aban's new additions could get better rates and, thus, keep the revenue and earnings growth momentum going.

High charter rates

Charter rates have been rising sharply as there are not enough rigs to meet the sudden pick-up in demand over the last two years. A rig takes two-three years to build. High oil prices have triggered oil exploration activity globally and increased the demand for rigs. The current charter rates are at almost three times the levels on existing contracts.

As the demand-supply mismatch is expected to continue at least for the next couple of years, Aban should command current charter rates, if not higher, for contracts due for renewal in 2007. Higher charter rates directly add to the bottomline. Recently, ONGC renewed its contract for Aban II for a further three years at thrice the rates it paid earlier. The earlier contract with ONGC expires in November 2006.

Financing Buys

Aban has been financing all its acquisitions through debt. In FY-05, debt rose three-fold and was at three times the shareholder funds. In FY-06, the company raised further debt of Rs 200 crore.

However, the return expected on its new investments could be substantially higher than the debt cost, thus creating value. For example, the company has spent $185 million (roughly Rs 830 crore) on `Aban Abraham'. But given the current charter rates, the payback may take just three years. Aban plans to issue yen-denominated FCCBs to raise roughly Rs 450 crore. This could expand the equity by 25 per cent. The earnings accrual could more than make up for the equity dilution.

The stock appears attractive from a long-term perspective and could outperform the broad market for a two/three-year period.

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