Why is the EV-to-EBITDA ratio important?
Offshore drilling companies are cyclical and volatile in nature. These companies are capital-intensive and have high levels of depreciation and amortization. Also, these companies have varying degrees of financial leverage, making them better valued when compared with their peers in terms of EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) ratio.
Current industry valuation
The highest and lowest forward industry EV-to-EBITDA ratios were 9.9x in 2006 and 2.8x in 2008, respectively. For more on this, read How to Interpret Valuation Multiples in the Offshore Drilling Industry.
What drives valuation multiples?
The forward EV-to-EBITDA ratio reflects what investors are willing to pay for the next four quarters of estimated EBITDA. In the offshore drilling (XLE) industry, we believe it reflects the perceived riskiness of investing in offshore drilling companies as well as investors’ expectations for the industry’s outlook.
In February, Brent crude oil prices touched $27 per barrel, a multiyear low. The prices in March rose by almost 50% compared to prices in February. Rising crude oil prices created positive sentiment among crude tanker investors, and the valuation multiples rose. However, analysts’ estimates have not changed significantly this month.
Changes in analysts’ estimates
Compared to one month ago, analysts’ 2016 EBITDA estimates have not changed much for Transocean (RIG), Ensco (ESV), or Diamond Offshore Drilling (DO). Their 2016 EBITDA estimates for Pacific Drilling (PACD) and Noble Corporation (NE) have fallen 1.1%, and 1.2%, respectively, while their estimate for Rowan Companies (RDC) has risen 1.3%.
To learn more about the basics of the offshore drilling industry, read Extracting the Basics: An Introduction to Offshore Drilling. For the latest industry updates, visit Market Realist’s Offshore Drilling page.