"Given the growing need for E&P companies to replace reserves and boost their production of natural gas, we expect further increases in the domestic land-rig count and in the dayrates of Grey Wolf Inc., which has substantial exposure to drilling natural gas wells," says Joe Agular, partner and oilfield service analyst for Johnson Rice & Co. in New Orleans. "Accordingly, we reiterate our Buy recommendation on the shares of GW." With a fleet of 120 domestic rigs, Houston-based Grey Wolf is the second-largest land drilling contractor in the U.S., with a leading position in its three core markets: South Texas, the Texas and Louisiana Gulf Coast, and the Ark-La-Texas region (northeastern Texas, northern Louisiana and southern Arkansas). The majority of GW's fleet consists of high-horsepower, deep-drilling rigs, making them particularly suited for gas-well drilling. During fiscal 1999, 96% of the wells Grey Wolf drilled were gas wells. Of its domestic fleet, 75 rigs are on the market, 34 are cold-stacked and the remainder are held for refurbishment. In addition, the company has five cold-stacked rigs in Venezuela. "With natural-gas prices now at seasonally high levels, bolstered by a favorable demand-growth outlook and the contraction in year-over-year production for many E&P companies, the outlook for strong gas prices and a continued increase in drilling activity is very promising," says Agular. In such an environment, Grey Wolf's operating leverage is substantial. At average dayrates of $7,800-which was reached in the last up cycle in late 1997-and a utilization level of 95%, GW generates $95- to $105 million in EBITDA (earnings before interest, taxes, depreciation and amortization) and earnings of 15 to 20 cents per share, the analyst says. "At replacement-level dayrates of $13,200 and 95% utilization, the company generates $325- to $330 million in EBITDA and 90 to 95 cents per share in earnings." Excluding the contribution from its turnkey projects, dayrates for Grey Wolf averaged nearly $6,300 in first-quarter 2000-a $300 increase over the average dayrate it attained in fourth-quarter 1999. In the same time, utilization of its total available fleet-109 rigs-increased to 56% from 54%; currently, utilization is 64%. Agular points out that much of the recent demand for land rigs by E&P companies has related to drilling deeper wells; this, in turn, has driven the demand for higher horsepower rigs. Grey Wolf and Nabors Industries control 80% of the rigs that can drill to depths greater than 15,000 feet-leaving pricing discipline in the hands of only two companies. The analyst adds that a recent equity infusion has decreased leverage concerns about Grey Wolf. "The company has $250 million in senior notes-which require interest-only payments until they mature in 2007-and now $67 million in cash following a late-March equity offering that netted GW $52 million," he says. "The cash infusion deleverages Grey Wolf's balance sheet, reducing debt to total capitalization to 59% from 67% at year-end 1999." Note: Analysis took place 4-27-00 when GW was $3.81 per share and was reaffirmed 6-2 when $5.19. Currently, some 178.5 million shares are outstanding. The recent 52-week price range was $5.18-$1.93.
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