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Hercules' Strength Defies Weakness

Posted: Jan 27, 2009 15:02 PM by Eric Fox

Tickers in this Article: SD, HK, RIG, CHK, HERO

It looks like investors overreacted to the credit crisis and slowdown in capital spending for Hercules Offshore (Nasdaq:HERO), an offshore drilling company with 35 jack-up rigs, 27 inland barges and 65 lifeboats. This investment misstep is offering long-term bulls an opportunity to play this higher risk name, as the stock is down 87% from its high reached over last summer.

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Acquisitions
Hercules Offshore has grown mostly through acquisition and has completed 15 acquisitions during the last few years. Its largest acquisition was the purchase of Todco in July 2007 for $2.4 billion. Todco was formerly owned by Transocean (NYSE:RIG), which spun it off several years ago when it decided to focus exclusively on the deepwater area. Hercules is not planning any acquisitions currently, as management said that it wants to focus on its balance sheet and financing is tough to get in the current environment. (To learn more about how to read these statements, see Breaking Down The Balance Sheet.)

Financials
Approximately 37% of Hercules Offshore's sales are international.

The company has $106 million in cash and debt of $1.15 billion at the end of the third quarter of 2008. The company had revolver availability of $223 million, giving it total liquidity of $329 million. The revolver does not mature until 2012. Its largest debt tranche is a term loan for $891 million that does not mature until July 2013. The company has two covenants that investors should watch out for. Hercules must maintain a maximum debt-to-last-12-months-EBITDA of less than 3.75, and its last 12 months EBITDA-to-fixed-charges must be more than 1.15.

Hercules would seem to have a long way to go until they break these covenants. During the third quarter conference call, Treasurer and VP of Finance Stephen Butz said that EBITDA would have to drop to the “low $200 million range” before it becomes a covenant issue. Even then, the company could cut capital expenditures further in 2009, where they are estimated to be $100 million.

Opportunity Knocks With Extra Risks
There are many risks associated with this strong company. Hercules Offshore’s customers have cut back spending during the last six months. Chesapeake Energy (NYSE:CHK), Petrohawk Energy Corp. (NYSE:HK) and Sandridge Energy (NYSE:SD) have reduced capital expenditures by $6.7 to $7.2 billion from previously planned spending in 2009-2010. Further reductions are probably in store in 2009, as many companies are still formulating their budgets.

Like other offshore drillers, Hercules does a lot of work in the shallow waters in the Gulf of Mexico, which exposes the company to hurricane risk. During the third quarter, the company suffered damage to one jack-up and one submersible rig. It also saw reduced utilization during the quarter.

Hercules Offshore has been more brutalized than some of its peers during the energy bear market due to investor perceptions on the leverage of the company and demand for its fleet. Bullish energy investors could see much higher return playing this name if the energy market rebounds higher in the coming years. (Learn more in The Industry Handbook: The Oil Services Industry.)

By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator.

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