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This article will  inform you about the organizing power contained in the financial metrics that I teach in my accounting and decision-making courses at Maharishi International University (Fairfield, Iowa, USA) and in the Student Investment Club where I act as the faculty adviser.

The worldwide economic slowdown and sinking oil prices have produced severe declines in stock prices of oilfield service companies, e.g., Noble (NE) down 90+%, Seadrill (SDRL) down 90+%, Transocean (RIG) down 90+%, Helmerich & Payne (HP) down 60%. When industries fall into the downswing of their periodic cycles, some companies go bankrupt and some companies survive and rise again. How do we separate opportunities for possible investments now from disasters that might come to pass? Tools of financial statement analysis can bring about insights into many of the key issues.

Among the many cases of decline, few compare to the puzzle that exists now for Atwood Oceanics (Symbol: ATW) where the company continues to report record profits and cash flow.  Yet, the stock price has fallen from $52.48 on May 31, 2014 to below $6.00 in February 2016 representing an 88% decline in market price.

Atwood Oceanics leases off-shore oil drilling rigs to large oil companies.  They have created a niche in the high-end technology side of rigs. During the last four years, ATW has spent nearly $3 billion replacing old equipment and adding new rigs to their fleet to prepare for the economic recovery to come. Nearly half of this investment was funded by its operating cash flow; the remainder was funded by long-term bank notes. This combination of financing sources is typical for funding long-term capital expenditures.

Using ATW’s financial statements for the year ending 9/30/2015, the following financial ratios paint a picture of a solid company:

Profitability and Cash Flow

  • 2015 Profits: $432 million (all-time record)
  • Return on Sales: 31% (rare to find companies with ROS>20%)
  • Return on Assets: 9% (better than most everyone in oilfield services)
  • Return on Equity: 15% (in line with favorable expectations)
  • Earnings Per Share: $6.68 (all-time record)
  • Operating Cash Flow per share: $9.32 (all-time record)
  • Price/Earnings Ratio: 1 (long-run average PE ratio for the broad stock market is 15 and in recent years for ATW it has been 10-12.  This suggests that the company’s stock price is significantly undervalued)

Solvency (ability to pay debts)

  • Current Ratio: 5:1 (healthy threshold is 2:1 or higher)
  • Debt/Asset Ratio: 0.39:1 (banks stop lending when ratio is 0.65 or higher; shows plenty of room to take on more debt if needed)
  • Number of times interest expense earned: 8 (bank get nervous when this ratio is <4)

Conclusions: Based on the latest financial statements, the company appears to be financially solid and the stock price appears to be undervalued. Why?

Analysts are split on ATW: Financial analysts are split about ATW’s future earnings and the depth of the negative effects to come. Some feel the stock is undervalued and is in a rare zone of opportunity. Others indicate the storm will catch the company in 2016 and it is not an opportune time to invest.

Although investors do rely on historical financial data to inform their decisions, they look more towards the future prospects to determine what to do. Some analysts might say that ATW’s financial storm has been delayed due to some special situations. Specifically, ATW has benefited from long-term contracts with customers who have continued to pay them due to contractual obligations negotiated years ago. For ATW, many of these contracts expire in 2016 and 2017. Some of the leases are expected to be cancelled. Others will be re-negotiated at lower rates. Thus, profitability for ATW is expected to fall significantly over the next two years. Now, the question involves estimates of how deeply ATW will be affected before the cyclical turnaround.

Possible Future Scenarios for ATW currently trading in the $6-7 range at PE of 1:

  • Bankruptcy due to extended deep oil depression. All investment is lost. Based on my analysis of the company’s financial situation and knowledge of management capabilities, this is a highly unlikely outcome.
  • Recovery (sometime in future) where the stock price rises again to somewhere near the range of 10-12 multiple of annual earnings which has been achieved for several years BEFORE the cyclical decline that began in 2013. For example, if earnings become $3.00 per share, the stock price could be in the $30-36 range. At $6.00 EPS, the stock valuation is likely to be in the range of $60-72 per share. Some form of this recovery is more likely.

I provide this analysis not as an investment advisor, but rather as an accountant who knows how to use the tools of financial analysis to evaluate profitability and solvency. If you accept Scenario #1, then you avoid investing now. If you choose to accept some degree of Scenario #2, then the current pricing of ATW could be attractive. If you are inclined to invest, you may want to seek the advice of a registered investment adviser.