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A Tribute to a Modern Day Hachiko - AKITA Drilling

A Tribute to a Modern Day Hachiko - AKITA Drilling

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Published by: jberkshire01 on Nov 24, 2010
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11/22/2012

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 1
 A Tribute to a Modern Day Hachiko
By Matthew Miller 
 There is a little known company that makes its home in Calgary, Alberta Canada.It is named after a Japanese dog breed and while I doubt anyone at the company  was ever directly inspired by the famous akita Hachiko, the company clearly demonstrates a loyalty to several managing principles that is reminiscent of theloyalty of that devoted canine. While I’ll get to the money making part in duecourse, first the quick story of the dog.Hachiko, who now lies stuffed in the National Science Museum of Tokyo, becamea national symbol of loyalty in Japan in the 1920’s and 30’s. Upon the death of hisowner, Hachiko devoutly returned to the Shibuya Train Station where he had met his owner each day before hisdeath. Hachiko didn’t do this for just a few days. He did it for nine years! The now long-famous dog has sinceinspired a bronze statue, an annual ceremony, films and books. Hachiko’s story is a story of loyalty. The story of AKITA Drilling Ltd. (TSX: AKT.A; OTCPK: AKTAF), on the other hand, is not only aboutloyalty but also making money. The C$160 million company is named after that breed of dog to which Hachikobelonged, and has been listed in Toronto since its spin-off from ATCO Ltd. in the early-to-mid 1990’s. AKITAis an oil and gas drilling contractor that primarily conducts its business in western Canada. While the company performs drilling operations for oil, heavy oil, and potash, the fortunes of the company are highly levered tonatural gas. The company, which operates wholly-owned and partner-owned rigs, owns 39 gross and 37.225 netdrilling rigs. The company has a wide-range of rigs and can service oil and gas companies seeking to drill atmultiple depths and can provide horizontal and pad drilling. While the majority of the company’s rigs service western Canada, the company has serviced customers in the lower 48 and Alaska. However, at the moment,these ancillary markets are a minor part of the company’s business. While there are many unique aspects to the company, the one that immediately jumps out at a potential investoris the company’s balance sheet. In atypical fashion, the company is debt free. In an industry which freely borrows to support rig construction, that is rare. In fact, when you look at the history of the company, thecompany reported positive net debt (i.e. more debt than cash) in only five quarters since the end of 1995. That was in 2001 and early 2002 when the company last heavily invested in rig construction and at the time the heavy investments were secured by long-term contracts to utilize the new equipment. I would argue, generally speaking, that the company has managed and continues to manage its balance sheet quite well for the industry in which it operates. The company’s management team, which has mostly been with the company since it was founded in the late1970’s, appears to be committed to operating in a somewhat counter cyclical manner. As I mentioned, the last wave of rig construction took place starting in 2000, not when natural gas prices were pushing $13 per MmBtu.Interestingly, the company currently believes now is another opportune time to be spending money and with itsbalance sheet is has the wherewithal to do so. The balance sheet boasts nearly $60 million in cash and no debt. AKITA is in the process of converting many of their drilling rigs, mostly deeper though some shallow, to padrigs. Pad rigs are more mobile rigs which allow for an assembly line-like drilling of prospects. Right now there isquite the demand for these rigs, which stands in stark contrast to the market for traditional rigs in westernCanada. In fact, the company just announced an agreement to build a new pad rig which I estimate will costbetween $15 and $20 million. The company has perhaps five or six more rigs that it could convert to pad rigs.Each of these conversions costs approximately $5 to $6 million. As you might imagine, having the ability toconvert older rigs at an incremental cost of 1/3 the price of a new pad rig is potentially appealing to the market. AKITA, which doesn’t focus on IRR’s on its assets, but instead focuses on payback periods, looks to securemost, if not all, conversions and new builds with long-term contracts. It targets four or five year paybacks on
 
 2new builds and slightly more aggressive targets on conversions (this would suggest at the low end perhaps anincremental $3 million in after-tax cash flows over the next five years from the recently announced deal). I wouldn’t be surprised to see the company continue to spend heavily on pad conversions. The company hasindicated that by the end of 2010 eleven rigs will have been converted to pads. With one additional conversionin process and five or six more that could be converted, AKITA’s fleet could be nearly 50% pad rigs in the notso distant future. I think this is changing the outlook for the businesses, especially in this difficult operating environment. The western Canada rig market currently has approximately 840 rigs. This gives AKITA a rig market share of approximately 4%. While this is not a large number, in the pad rig business the company is reportedly a muchlarger player. Management at AKITA estimates the western Canada pad rig market to be in the 30’s, which would suggest a market share in this business of approximately 30%. As you might imagine, the current market for drilling natural gas in Canada is not robust. Below is a long-termpicture of the active Canada rig count presented by Baker Hughes. While 2010 has shown quite a recovery from2009, the market remains far from its highs. The following natural gas price chart (www.tradingeconomics.com) provides, in addition to the credit disruptionsof the last few years, a good explanation as to the current state of affairs in the drilling business. This environment has put extreme pressure on rig utilization in western Canada. The accompanying table presents rig utilizationfor the industry and for AKITA. It would appear that there arethree primary conclusions that can be drawn. First, industry wideutilization is far below the 10 year average. Second, AKITAseems to outperform the industry in terms of utilization. And,three, AKITA’s opportunity in pad rigs, as reflected in the recentdisclosure of the utilization of those particular rigs, seemsintriguing.
Baker Hughes Rig CountCandaian Market
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 JAN 502 539 405 478 554 550 660 568 494 377 459FEB 544 562 433 554 568 593 715 635 620 413 564MAR 394 445 311 449 462 420 620 392 408 196 386 APR 146 217 121 151 153 183 198 101 106 74 123MAY 189 238 114 150 187 247 240 107 135 72 147 JUN 301 302 205 308 265 293 408 210 266 125 229 JUL 308 319 266 398 351 450 553 349 435 175 350 AUG 319 325 235 404 353 545 482 343 449 178 387SEP 314 317 250 348 273 497 446 351 435 208 347OCT 353 304 220 394 372 541 431 338 446 244 398NOV 362 266 281 412 447 600 432 371 417 277DEC 410 264 348 417 440 575 456 360 361 313 AVG 345 342 266 372 369 458 470 344 381 221
 
 AKITA Drilling Ltd.Rig Utilization vs. Industry
 AKITA Detailed Utilization Year AKITA Industry Conventional Pad2010 YTD 36.5 31.92009 31.1 24.8 23.7 59.52008 42.2 41.72007 40.9 37.02006 56.6 55.12005 59.3 58.82004 52.2 52.92003 54.7 53.12002 46.8 39.22001 56.9 53.02000 60.0 55.200 - 09 Avg 50.1 47.1
 
 3 As you might next imagine, this state of affairs, especially given the high fixed costs of the business, has led topricing issues. The following set of tables shows what the last few years have looked like for AKITA. Generally speaking, operating margin per operating day has been under a fair amount of pressure. This is in spite of thefact, in AKITA’s case, that the company has gradually been becoming more of a pad rig player where utilizationand pricing has been much stronger.
 Accounting Can Be Important
  As with any capital intensive business, depreciation is a significant factor. For instance, over the last ten yearsdepreciation has represented, on average, 15.2% of AKITA’s revenues and 17% of its total costs. This makesthe assumptions which drive depreciation quite important. What is particularly interesting and illuminating whenit comes to assessing management is that the company depreciates its rigs over 2,000 operating days (thecompany does also depreciate five rigs over 3,600 days). According to my work, this is far faster than mostdrillers in the industry. See the chart below for a sample of what the industry uses for depreciation rates. While it is certainly difficult to compare each of these companies, especially when several companies have chosento use a different depreciation method than AKITA and several companies do little more than disclose a rangefor their entire rig segment (which often includes non-rig ancillary equipment which tends to be depreciatedmuch faster), the table suggests AKITA depreciates its rigs far faster than many in the industry. In fact, youcould say that it depreciates its rigs nearly twice as fast, when operating, as many in the industry. This obviously has a large impact on earnings.
 AKITA Drilling Ltd.AKITA Drilling Ltd.Revenue per Operating DayOperating Margin Dollars per Operating Day
2006 2007 2008 2009 2010 2006 2007 2008 2009 2010Q1 $22,911 $24,661 $23,012 $24,923 $19,539 Q1 $9,984 $10,596 $9,746 $9,890 $6,788Q2 $19,993 $23,412 $21,665 $29,604 $22,173 Q2 $8,880 $9,708 $7,346 $11,477 $7,455Q3 $21,003 $20,755 $19,723 $21,018 Q3 $8,885 $6,834 $7,747 $6,061Q4 $22,912 $22,595 $23,212 $21,840 Q4 NA $9,390 $6,739 $7,713 AVG $21,705 $22,856 $21,903 $24,346 AVG $9,250 $9,132 $7,895 $8,785
 AKITA Drilling Ltd.AKITA Drilling Ltd.Operating and Maintenance Costs per Operating DayOperating Margin per Operating Day
2006 2007 2008 2009 2010 2006 2007 2008 2009 2010Q1 $12,927 $14,065 $13,266 $15,033 $12,751 Q1 43.58% 42.97% 42.35% 39.68% 34.74%Q2 $11,113 $13,704 $14,319 $18,127 $14,718 Q2 44.42% 41.47% 33.91% 38.77% 33.62%Q3 $12,118 $13,921 $11,976 $14,957 Q3 42.30% 32.93% 39.28% 28.84%Q4 NA $13,205 $16,473 $14,127 Q4 NA 41.56% 29.03% 35.32% AVG $12,053 $13,724 $14,009 $15,561 AVG 43.43% 39.73% 36.14% 35.65% 34.18%
 AKITA Drilling LtdComparable Company Depreciation Rates
Company Low High Method Additional NotesCathedral Energy Services Ltd. 4 yrs 10 yrs declining balance Total Energy Services Inc. 5 yrs 15 yrs straight lineEnsign Energy Services Inc. 3,650 days unit of production on rigs Tuscany International Drilling Inc. 10 yrs straight linePrecision Drilling Corporation 5,000 days unit of production Technicoil Corp. 2 yrs 15 yrs straight line more geared toward well servicing Nabors Industries Ltd. 4,900 days unit of production on rigs, not jack-ups Trinidad Drilling Ltd. 4,200 days unit of production on rigs onl AKITA Drilling Ltd. 2,000 days 3,600 days unit of production just 5 of 37.225 net rigs at 3,600Xtreme Coil Drilling Corp. 5,000 days unit of production slightly different techSavanna Energy Services Corp. 1,500 days 4,125 days unit of productionHelmerich & Payne Inc. 4 yrs 15 yrs straight line includes contract drilling equipmentPatterson-UTI Energy Inc. 2 yrs 15 yrs straight line includes other equipmentUnit Corp. 15 yrs unit of production rates starting at 15 yrsRowan Companies Inc. 12 yrs 15 yrs straight linePioneer Drilling Co. 3 yrs 25 yrs rigs and equipmentParker Drilling Co. 15 yrs 20 yrs land drilling equipmentUnion Drilling, Inc. 2 yrs 12 yrs includes related equipmentBronco Drilling Co. Inc. 3 yrs 15 yrs includes related equipment

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