Investor's Business Daily, April 24th, 2007
The search for new sources of oil and gas is moving farther offshore.
The utilization rate for the world's offshore floating rigs that operate in 500 feet of water or more stood at 96%, according to ODS-Petrodata, which provides data to the offshore energy field. That's up from 72% at the end of 2003.
The number of working offshore floating rigs has grown by 32% since the end of 2003, says analyst James West of Lehman Brothers. The activity level for these rigs has been above 90% since mid-2005 and in the mid 90% range since the middle of last year.
Increased drilling has led to greater demand for gear used to produce the fields.
Dril-Quip DRQ is one company tapping into this trend. It makes offshore drilling and production equipment. Almost all its products are geared for use in water more than 1,000 feet.
There's been a big expansion in deep water drilling activity, says West. "We've picked all the low-hanging fruit on land, and we've been exploiting the shallow water," he said. "The natural expansion is into the deep water."
Plus, since the oil projects on land in regions such as the Mideast and parts of Asia are controlled by the national oil companies, the big oil concerns such as Exxon Mobil XOM have to go into deeper water, he adds.
"What you're seeing in the subsea market is a secular growth trend," added analyst David Anderson of UBS Securities, which has an investment banking relationship with Dril-Quip. "In terms of subsea applications and equipment, deep water is a main area of focus and one of the few remaining frontiers in oil and gas exploration."
Wellheads
Dril-Quip's deep-water products include subsea wellheads. These are pressurized metal housings in which casing hangers are landed and sealed underwater to suspend casing. They're used when drilling from floating drilling rigs.
The Houston-based company also makes mudline hanger systems. They're used in jack-up drilling operations to support the weight of various casing strings at the ocean floor while drilling.
Another key product is a subsea production tree.
This is an assembly of valves, a wellhead connector, and other components installed on a subsea wellhead or mudline hanger system. It's used to control the flow of oil and gas from producing wells.
In 2006, 65% of the company's sales came from overseas.
Dril-Quip holds less than a 5% share of the global subsea tree market, says analyst West. It has a bigger share in subsea wellheads.
Executives weren't available. But Dril-Quip stands to benefit from new products, which complement its subsea production tree line, watchers say. New products include subsea control systems used to remotely control the operations of subsea production gear such as subsea trees.
Another is a subsea manifold, which is a structure based on the ocean floor. It consists of valves and other gear used to collect and control the flow of oil and gas from subsea wells for delivery to a terminal.
In December 2005, Dril-Quip delivered a multiplex subsea control system to an operator in the North Sea. It also installed its first subsea manifold system.
It supplied another subsea control system and subsea tree to the Dutch sector of the North Sea in the summer of 2005. It started operating last year.
The key reason behind adding these new products is that subsea trees are often sold as fully integrated packages with manifolds and controls systems, says West. Prior to adding the new gear, Dril-Quip only competed for smaller development projects involving, say, one or two subsea trees.
With the new products, Dril-Quip can offer fully integrated solutions for larger subsea field development projects involving 10 or more subsea trees, he says.
"I believe they could be close to winning a small to mid-sized integrated package," he added.
This could be for up to 10 subsea trees and associated control systems and manifolds.
He says there are lots of projects involving 20 or more subsea trees Dril-Quip can vie for. They include projects offshore in the Gulf of Mexico, West Africa and the North Sea.
Meanwhile, Dril-Quip's business has been growing at a steady clip. From 2002 to 2006, earnings grew at an average annual rate of 45% and sales by 16%.
In the fourth quarter earnings rose 91% from the prior year to 61 cents per share. Sales jumped 25% to $118.3 million.
As of Dec. 31, its backlog stood at $336 million, up from $248 million at the end of 2005.
"Their market share has not appreciably increased. However, the overall size of the market has grown quite a bit over the years." said analyst Anderson.
In-House Production
One factor contributing to its growth, he adds, is its approach to manufacturing.
Dril-Quip produces most of its forging and heat-treating products.
Anderson says Dril-Quip is the only vertically integrated manufacturer in its field of which he is aware.
"Vertically integrated companies do well in the upper part of a cycle," he said. "If they don't outsource, their cost base can be a lot lower."
Analysts polled by Thomson Financial expect this year's earnings to rise 24% to $2.63 a share, then another 21% in 2008.
Anderson expects deep water production to continue to be a major focus in the industry. Key areas of growth include offshore Brazil, the Gulf of Mexico and Southeast Asia.
"We continue to see substantial growth in the oil field service industry," he said. "Pricing power is starting to increase among the subsea suppliers and in addition the pie is continuing to get bigger."
