ADNOC Drilling – the drilling subsidiary of the Abu Dhabi National Oil Company (ADNOC) – provides drilling and construction services in the United Arab Emirates (UAE). The company operates through four segments: Onshore (47% of 9M24 sales), Offshore Jack-up (30%), Oilfield Services (18%) and Offshore Island (5%). The company operates primarily in the UAE.

Enormous unconventional reserves and GCC expansion to drive future growth

Abu Dhabi is estimated to possess around 220 billion barrels of unconventional oil and 460 trillion cubic feet of unconventional gas. The emirate has set an ambitious target of extracting one billion cubic feet of gas per day by 2030 for which it needs to develop 200-300 wells annually, necessitating the deployment of 20-30 rigs each year. Such an expansion is expected to more than double ADNOC Drilling’s rig count by 2030 from the current 140. Encouragingly, ADNOC Drilling signed a large deal (worth $1.7bn) with the Abu Dhabi Government on 13 May 2024 for the first phase of unconventional energy resources development. In this context, it envisages the deployment of 14 rigs to develop and drill 144 oil and gas wells by 2026.

With the above development, we believe the company will likely transform itself as a prominent player in the unconventional energy resource development space in the Gulf Cooperation Council (GCC). As part of its long-term strategy to make further inroads into unconventional energy development, ADNOC Drilling is evaluating both organic and inorganic opportunities in the GCC. It started operating its rig in Jordan (first rig outside the UAE) in 1Q24. Additionally, it has secured a pre-qualification in Kuwait and is close to completing the pre-qualification process in Oman.

Guidance revised upwards

ADNOC Drilling reported a significant 28% year-over-year (YoY) increase in sales to $2.8bn in 9M24 driven by new rigs commencing operations, and increased activity in drilling fluids and wireline services. Furthermore, EBITDA margin widened to 50% (vs 48% in 9M23) on higher sales and operational efficiencies.

The company has raised its 2024 guidance for the second time, driven by the exceptional 9M24 performance. It now expects sales of $3.80bn-3.90bn in 2024 (up 21-26% YoY) from the $3.70bn-3.85bn estimated earlier. Additionally, it has revised EBITDA outlook to $1.85bn-1.95bn from $1.80bn-1.95bn. The EBITDA margin is projected to remain flat at 49-51%. Furthermore, net income guidance has been revised upward to $1.20bn-1.30bn (vs $1.15bn-1.30bn), with a profit margin forecast of 31-34%. The company has also upped its medium-term sales growth guidance thanks to increased visibility from the Abu Dhabi contract. It now expects a CAGR of 14-18% (vs 14-16% earlier). The revised guidance excludes the future phase of the Abu Dhabi contract and expansion into the GCC.

Consistent positive FCF to support rig expansion and dividend payouts

The company has consistently generated positive free cash flow over the past three years. Capital expenditure (capex) is expected to remain elevated in 2024, primarily due to the deployment of rigs for the Abu Dhabi government contract. It has projected capex of $800mn-900mn for 2024, including maintenance capex. Additionally, it has provided annual maintenance capex guidance of $200mn-250mn post-2024.

The company’s net leverage stood at 1.1x in 3Q24 (within the company’s long-term target of less than 2.0x, implying ample headroom). Consensus estimates the ratio to improve to 0.76x by end-2025, due to an expected increase in free cash flow to $1.4bn in 2025 (vs $768mn expected in 2024). Hence, the company has introduced a new dividend policy, with annual dividend growth guidance of ‘at least 10%’ over the next five years from ‘at least 5%’ earlier. In 1H24, it declared a dividend of 9.05 fils per share (dividend yield: 3.7%) – an increase of 10% YoY.

In conclusion, ADNOC Drilling offers strong future opportunities, bolstered by its unconventional development contract in the UAE and the potential benefits from the future phases of the contract. Additionally, the expected contribution from the Enersol JV and strategic expansion across the GCC further enhance its appeal. The stock price is up around 40% year-to-date, rising approximately 26% since the announcement of the Abu Dhabi contract. Despite these gains, valuation remains in line with its historical average and peers’. The scrip is currently trading at a P/E ratio of 18.3x (vs five-year average of 18.8x and global peer average of 17.9x). Over the past couple of quarters, FY25 and FY26 sales and earnings projections have been revised upwards by a consensus of 14 analysts. Most analysts have a ‘Buy’ recommendation, with an average price target of USD1.535, indicating an upside potential of around 7%.

However, several major risks could significantly impact ADNOC Drilling. These include a prolonged economic slowdown in global markets, particularly in China, fluctuations in oil and gas prices, changes in environmental regulations and drilling policies, and political instability in the regions where ADNOC operates. These factors will likely put significant pressure on the company’s financials. Additionally, the high leverage resulting from funding expansion plans could weaken the balance sheet.