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Growing PNG LNG Demand

We believe that PNG’s close proximity to major emerging economies will continue to attract supermajors to establish exploration and development projects in the country. This is due to three main reasons. First, PNG offers the lowest shipment cost to Asian markets. Second, we believe that demand for LNG will continue to rise as countries such as Japan, South Korea, Taiwan, China, and India are expected to remain the backbone of the global LNG market. Furthermore, we believe that governments in the South Asia region will slowly phase out coal as an energy source due to environmental concerns. Last, the PNG government is receptive to foreign capital investment, especially for LNG projects as the country strives to become a significant energy exporter. As such, we believe that HWO will significantly benefit from the growing demand for well and drilling services in PNG.

Diversified Operations Provides Price Cushion

As oil prices continue to linger in the sub-$40 territory, many Canadian upstream oil and gas companies are cutting back on drilling activity and other capital expenditures. As such, Canadian oilfield services companies, whose revenue depend on upstream companies, are also negatively impacted. This notion is evident in the graph on the left which displays the price performance of HWO and its competitors. It is clearly observed that HWO’s stock has declined by only 13.6% compared to an average decline of 68.6% among HWO’s competitors. This relatively minor price decline can be attributed to HWO’s diversified operations, which serves as a cushion for any fluctuations in oil and natural gas prices. This unique mix of operation makes HWO a very attractive candidate for investors seeking limited downside with foreseeable upside.

Barriers to Entry

Though PNG is an independent country with established democracy and a stable business jurisdiction, foreign corporations remain reluctant to establish operations in the country due to sporadic political upheavals and tribal disputes. Though this is certainly a risk, it is also an opportunity for HWO to continue expanding its presence in PNG. Furthermore, given that the company has been operating for over 10 years in PNG, HWO has established its reputation as a leading drilling services provider in the region. In addition, the company has the most advanced and newest rigs in the country, which makes HWO an attractive company to do business with.

Valuation

We are initiating a target price of $7.50 per share on HWO. We believe that the current valuation of 2.3x 2016 EV/EBITDA is not justified due to three main reasons. First, HWO has a leading market position in PNG and benefits from multi-year contracts which provide visibility. Second, HWO is well-capitalized and has minimal leverage. Lastly, the company is poised to take advantage of the growing demand for LNG in Asia given its fleet of advanced drilling rigs. Our bullish stance on HWO is driven by the DCF valuation of $7.50 and target 2016 P/E of 10.0x.

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Alpha Insights

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