RJ's Report on TDG

TARGET: $10.00
JANUARY 6, 2009

Trinidad Drilling Ltd.
TDG-TSX
The Disconnection Between Trinidad’s Operations
and Its Valuation
Event
Trinidad’s shares underperformed its mid‐ to large‐cap oilfield peers through
most of the fourth quarter, commensurate with the deepening of the global
credit crisis. The stock began to regain some of this lost ground over the last
several trading sessions.

Action
Our view here hasn’t changed: Trinidad remains our Top Pick. We believe
Trinidad is a strong operator in both Canada and the U.S. and that its share
price will reflect the cash flow that these operations generate. We continue to
rate Trinidad shares STRONG BUY.

Analysis
Our fundamental approach naturally biases us toward evaluating Trinidad’s
operations, and predicating our recommendations on these observations. In
this report, we take the opportunity to discuss Trinidad’s operations outside
the crowded context of quarterly reporting seasons to provide investors with
some insight as to Trinidad’s performance in both Canada and the U.S. In
particular, we find that (a) Trinidad is significantly outperforming its
Canadian contract drilling peers; (b) Trinidad’s U.S. utilization is above most
larger peers, and we expect this gap to widen as the downturn deepens
(similar to what has happened for Trinidad in Canada); (c) that its aboveaverage
debt levels have trumped its strong operational performance (though
we don’t expect this to last), and (d) that its convertible debentures (TDG.ZTSX,
not covered) provide a lower risk investment opportunity for investors
who appreciate Trinidad’s operational performance, but are wary of the equity
risk.

Valuation
Our target valuation for Trinidad is 5.0 times 2009E cash flow, 6.2 times 2009E
EV/EBITDA, and 13.3 times 2009E earnings. We arrive at these target
valuations by applying a discount to the average trading ranges we have
observed in other mid‐ to large‐cap oilfield equities during down‐cycle
periods. The discount is in deference to its higher‐than‐average debt levels.

RATING & TARGET
RATING =
Target Price (6-12 mths) =
Closing Price
Total Return to Target 139%
MARKET DATA
Market Capitalization ($mln) 4 30
Current Net Debt ($mln) 595
Enterprise Value ($mln) 1 ,025
Shares Outstanding (mln, f.d.) 105.7
Avg Daily Dollar Volume (3mo, mln) 5.5
52 Week Range $15.45 / $3.45

STRONG BUY 1
Trinidad Energy Services Trust is a Canadian based drilling
contractor with operations in western Canada and the
southern U.S. Trinidad's rig portfolio is largely comprised of
deeper rigs. The trust also operates service rigs, coring rigs,
surface hole rigs and inland barge rigs.

Operational Summary
With operations as diverse as Trinidad’s have become, there is no quick
answer to the “how’s the company doing” question. As a refresher, Trinidad’s
drilling fleets now include 57 rigs in Canada, 53 land rigs in the lower 48
states, 3 land rigs in Mexico, and a barge rig in Louisiana. In addition,
Trinidad has 13 more high‐horsepower land rigs under construction due for
delivery to its U.S. customers by the end of the year.
And on top of its drilling operations, Trinidad has a fleet of 21 service rigs
(with five more to be delivered through 2008), 11 coring rigs, 9 “rathole”
drilling units; it operates 3 bareboat charters and has a rig construction and
engineering division.
To summarize these operations, we’d observe that Trinidad is generally
outperforming its peers in its major markets. In particular:
�� Canadian drilling is going very well for Trinidad, in spite of weak
overall demand.
�� U.S. drilling is holding up well, though utilization is beginning to sag
on its un‐contracted rigs.
�� The barge market is roughly status quo from third quarter levels.
�� The Mexico operations are just getting underway and should hit fullstride
by mid‐quarter.
We will confine our discussion of Trinidad’s operations to its Canadian and
U.S. land drilling businesses, as these generate the vast majority of Trinidad’s
revenues and cash flow.

Contracts and Customer Concentration
Many investors express misgivings or wariness with respect to Trinidad’s
long‐term rig contracts. In our view, however, the types of contracts on
Trinidad’s rigs tend to hold up very well when stressed by market conditions,
not because Trinidad has retained a cadre of vicious lawyers ready to sue its
customers for performance, but rather because the rigs Trinidad has
contracted are high quality and generally scarce in the land drilling market
place. In other words, the best defense in a weak market is for a driller to
operate the best performing equipment.
As evidence in support of our view, remember that Canada already
experienced a significant downturn that began late in 2006. As such, we have
already seen a real‐world trial of these new rig contracts. And whether it was
Trinidad, Savanna (SVY‐TSX, OUTPERFORM, recent: $8.74) or Stoneham
(SDG.UN‐TSX, OUTPERFORM, recent: $3.42), the utilization and dayrate
performance from these companies were consistently head and shoulders
above the larger legacy fleets.
Trinidad has 63 rigs under long‐term, take‐or‐pay style contracts, including 13
rigs that are currently under construction. The average duration of these
contracts is about 2.5 years. More than 75% of these contracts are on its U.S.
rigs.
Trinidad’s largest customer for its contracted rigs is EnCana (ECA‐TSX/ECANYSE,
MARKET PERFORM, recent: $51.38). Its second largest customer is
Chesapeake (CHK‐NYSE, not covered). Note that we published a detailed
analysis of Trinidad’s exposure to Chesapeake on Oct‐14‐08 titled, “A Rough
Week at Chesapeake Results in More Capex Cuts” ($6.75 share price). One of the
conclusions of this report was that the risks in Trinidad’s contracts with
Chesapeake are more perceived than real; Trinidad is Chesapeake’s preferred
supplier and Chesapeake is motivated to keep Trinidad’s rigs for cost‐efficient
play development.
After EnCana and Chesapeake, about half of Trinidad’s 63 rig contracts are
allocated to a diverse group of producers, none with more than four (4)
Trinidad rigs under contract.

Canadian Operations Performing Above Average – As
Usual
While not all the numbers are in yet, at this stage it looks to us like Trinidad’s
Canadian rigs averaged about 59% utilization during 4Q08, which is about 14
percentage points higher than the industry average. Put another way, the
preliminary data suggests that the average Trinidad rig worked 4 days for
every 3 that the average Canadian rig worked during the quarter.
Of course this is nothing new. Trinidad has a long track record of posting
utilization rates in excess of its Canadian peers. Over 2008, we calculate that
Trinidad’s rigs generated, on average, 37% more revenue days than the
industry’s average rig (see Exhibit 1).

More currently, and with the understanding that it’s just point‐in‐time data,
the most recent utilization figures show Trinidad at 70% utilization in Canada
compared to the 42% industry average. As we understand it, Trinidad’s rigs
are just about entirely booked through the winter drilling season, so we expect
a continuation of above‐average utilization figures from Trinidad for the first
quarter from Trinidad, similar to the 71% utilization it achieved in the first
quarter last year.
Trinidad’s Canadian customer base is well‐diversified. EnCana will almost
certainly retain top client spot for Trinidad in Canada for the foreseeable
future, but the client list spreads‐out from there (see Exhibit 2). One thread of
commonality that tends to run through Trinidad’s Canadian clients is that they
tend to use Trinidad to develop the deeper unconventional plays (we judge
based on the locations of the active rigs).

U.S. Operations Still Holding Up Well – And We Forecast
Them to Outperform, Just As In Canada
Reliable third party data on company‐specific operating statistics are harder to
come by for U.S. drilling contractors. As it is, we understand that utilization on
Trinidad’s land fleet is still in the 80‐85% range today, which is consistent with
our financial forecasting for Trinidad. Average utilization on its U.S. rigs was
86% in 3Q08 and we’re estimating 83% and 80% for 4Q08 and 1Q09,
respectively. The small decline experienced to date has been confined to
Trinidad’s 20 or so un‐contracted rigs, primarily from its 2005 Cheyenne
acquisition. We expect utilization in these rigs will begin to fall precipitously
through the year and this is embedded in our estimates.
Overall, however, we expect Trinidad’s U.S. utilization will remain above 70%
throughout 2009, even as the industry average drops to below 50%. This is
similar to Trinidad’s experiences in Canada and is consistent with other highend
U.S.‐based drillers like Helmerich & Payne (HP‐NYSE, not covered).
One set of statistics we can observe through third party publications is that
Trinidad’s U.S. rigs are generally strong performers and are heavily focused
on unconventional play‐types. Firstly, we notice that Trinidad’s U.S. fleet
comprises only 2% of the total U.S. rig fleet, yet its rigs complete about 3% of
total U.S. footage drilled. Secondly, Trinidad’s rigs complete 4.4% of the
horizontal footage in the U.S., again with just 2% of the rigs. Thirdly, Trinidad
consistently shows up as one of the deepest average drillers in the U.S.
Ordinarily, deep drilling should frustrate total footage‐drilled measures
because penetration rates decrease as wells go deeper. In other words, the
shallower drillers should be outpacing Trinidad in terms of footage‐drilled,
but Trinidad is outpacing them.

Valuation
Trinidad screens as a very attractive value‐oriented candidate on the Canadian
oilfield landscape. As we show in Exhibit 3, Trinidad’s shares are trading at 2.2
times 2009E cash flow, which is significantly below its mid‐ to large‐cap peer
group (the peer group average is 4.7 times 2009E cash flow). As well, Trinidad
is currently priced at 4.0 times 2009E EV/EBITDA; again significantly below
the 4.9 times 2009E EV/EBITDA mid‐ to large‐cap peer group average.
Average 2009E P/Es for the mid‐ to large‐cap peer group is 11.8 times, whereas
Trinidad is currently priced at 5.9 times. Lastly, the market is valuing Trinidad
at 0.6 times its book value, compared to 1.0 times for the peer group average.
We appreciate that the market has taken a dim view of companies carrying
higher debt levels, and on this point we’d estimate Trinidad’s total debt load,
including its $354 million in convertible debentures, at approximately $600
million, or 2.4 times 2009E EBITDA.
We have endeavoured to explain that Trinidad’s debt involves very little in
annual principal repayments; and the interest payments are more than
adequately covered (about 5 times covered); and that Trinidad is not
anywhere near testing any of its debt covenants; and that even in the unlikely
event that its facilities were not renewed by its syndicate of lenders, it would
be readily manageable for Trinidad to repay them on time as per their terms.
But as thoughtfully engineered as Trinidad’s capital structure may be, the
market is considering worst‐case scenarios as a starting point for analysis, and
as such, Trinidad’s valuation has suffered.
But it is worth pointing out in this context that Trinidad still has financial
flexibility since it is still paying‐out about $58 million in annualized dividends.
This is a potential source of cash that could be used for debt reduction (ideally,
we’d like to see Trinidad buy‐back some of the convertible debentures). In fact,
considering the 13.5% yield on Trinidad’s shares, we wouldn’t be surprised if
Trinidad’s Board elected for a dividend reduction in the not‐too distant future.

Like the Operations But Not the Debt? Take a Look at
the Debentures
The bulk of Trinidad’s debt resides within its convertible debentures: 59% or
roughly $354 million of $600 million.
Since their July 2007 issue, the debentures spent most of their time priced
between 95 and 104 (par value is 100). Then in early October 2008, the
debentures began falling precipitously, bottoming at 52.50 before recovering to
the recent 65 price.
At yesterday’s closing price, investors receive an 11.9% cash yield, plus a
prospective 12.8% annualized capital gain to maturity (the debentures mature
July‐31‐2012) for a total prospective 24.7% return. Investors should appreciate
that upon maturity, the principal may be repaid in cash or in Trinidad shares,
at Trinidad’s discretion. If Trinidad were to elect to pay in shares, the number
of shares would be equal to the principal amount of debentures divided by
95% of the then prevailing share price – details are available in the Jun‐26‐07
Short Form Prospectus filed on the SEDAR website.
In our view, the debentures provide a higher degree of security than
Trinidad’s common shares and still present an attractive risk‐adjusted return.