Seeking Alpha
Short only, special situations, growth at reasonable price
Profile| Send Message|
( followers)

Introduction

Oil is the lifeblood of all activity that takes place in the world today. Its demand is driven by an increasing population, economic activity and transportation needs. The general trend for the demand for oil has been bullish since the time oil was first discovered. Although many alternative fuel sources have been discovered over the course of the last few decades, oil still remains as the top contender for ensuring economic stability. As the world is running out of cheap oil, fluctuations in global oil prices have become more frequent. This has not only created more challenges for the oil and gas exploration and drilling companies; it has also provided them with golden opportunities.

In this article I will conduct a competitive analysis of three oil and gas drilling companies: Seadrill Ltd. (NYSE:SDRL), Transocean Ltd. (NYSE:RIG), and Ensco PLC (NYSE:ESV) to determine which driller is the best bet for now.

Seadrill

Seadrill's revenues in the last five years have grown from $1.676 billion to $4.322 billion. However, it must be noted that a threefold increase in revenue has only resulted in a twofold increase in net income. One of the factors that attributed to the net income not increasing in line with the revenues is the increasing depreciation of the company's assets over time and, secondly, the provisions that have been made for income taxes. These figures have affected the earnings figures.

Comparing SDRL's ratios to the industry average, it can be inferred that, according to the P/E ratio, SDRL is an undervalued stock, while the P/B and P/S ratios indicate otherwise. The dividend yield of SDRL is far better than the industry average, making it a very attractive investment for investors. The increasing dividend payout ratio since 2009 can be one of the reasons why Seadrill's stock price has experienced a steady increase. An increase in demand for the stock due to attractive dividends may have caused the price of the stock to inflate.

Indicator

SDRL

Industry Avg

S&P 500

SDRL 5Y Avg

Price/Earnings

18.3

25.2

16.2

6.3

Price/Book

2.9

1.4

2.2

2.4

Price/Sales

4.2

2.2

1.4

3.4

Dividend Yield %

6.6

1.5

2.3

9.1

Source: Morningstar

The company also has a very high Return on Equity (15.9%), when compared to the industry average (-0.2%). This may appear favorable at first glance, but it must be kept in mind that the company also has a high debt to equity ratio as shown in the table below. Due to its high leveraging, the company's ROE is overstated.

Transocean

The P/E, P/B, and the P/S ratios indicate that Transocean is a slightly undervalued company. The company did not pay any dividends in the last fiscal year because it had negative earnings. The company has a negative ROE of -1.4%, which is worse than the industry ROE of -0.2%. This has been due to a loss of $0.219 billion in the fiscal year 2011-2012. The debt to equity ratio of 0.7 is also worse than the industry average of 0.5. However, it should be noted that Transocean owns the world's largest offshore drilling fleet. It can use this strength to its advantage as more customer orders for offshore drilling arise in the near future, especially in the Arctic.

Indicators

RIG

Industry Avg

S&P 500

RIG 5Y Avg

Price/Earnings

23.6

25.2

16.2

10.6

Price/Book

1.2

1.4

2.2

1.0

Price/Sales

2.1

2.2

1.4

1.8

Dividend Yield %

1.5

1.5

2.3

-

Ensco

Ensco is a company that has focused on cost cutting to increase its earnings from operations. According to Morningstar's analyst report, Ensco has significant cost cutting opportunities available to further push down its costs and lead to "further value creation". Ensco's P/E ratio is significantly lower than the industry average, which means that the stock is undervalued. The P/B ratio also indicates that the stock is under priced, but only slightly. On the other hand, contrary to what the P/E and the P/B ratios state, Ensco's P/S ratio is significantly higher than the industry average, indicating that the stock is overvalued.

Indicators

ESV

Industry Avg

S&P 500

ESV 5Y Avg*

Price/Earnings

11.4

25.2

16.2

10.3

Price/Book

1.2

1.4

2.2

1.1

Price/Sales

3.2

2.2

1.4

3.0

Dividend Yield %

2.7

1.5

2.3

1.6

The company's dividend yield of last year was higher than the industry, making it an attractive stock in case investors are looking for dividends. The company has steadily paid out dividends to its investors in the past. It is a healthy sign that the company is likely to continue this practice in the future. The company has an ROE of 10.3, which is significantly higher than the industry ROE of -0.2. A debt to equity ratio of less than one is a healthy sign, indicating that the company is more reliant on equity based financing. Furthermore, the debt to equity ratio of 0.4 is better than the industry average of 0.5.

Fair Stock Valuation

There are many ways to estimate the fair stock value of a company. For this purpose, we applied the discounted-earnings-plus-equity model developed by EFS Investment analysts to these competitors.

Indicator

SDRL

RIG

ESV

Current Price

$37.64

$53.27

$58.69

Estimated Fair Value Range

$30-$43

$67-$111

$66-$117

Current Stock Valuation

Fairly valued

Undervalued

Undervalued

Upside Potential (Premium) to Reach a Fair Stock Value

--

27%

13%

Data from Morningstar and Financial Visualizations on March 19, 2013

The calculations based on this model allow us to suggest the following: currently, both RIG and ESV stocks are undervalued, whereas the SDRL stock is fairly valued. In addition, EFS's fair stock price valuation indicates that Transocean is trading at the most attractive discount.

Conclusion

Based upon the above analysis, it can be concluded that Ensco is a better stock than Seadrill and Transocean. Not only is Seadrill overvalued according to the multiples approach, its high debt-to-equity could spell trouble for the company if it is unable to meet its debt obligations in the future. Transocean has reported losses for the past two years. However, the situation of its operating expenses is gradually improving. As it is a slightly undervalued company, the gain in its price over the next year would not be that significant when investors incorporate current and past market data when deciding whether or not to trade this stock. Apart from the P/S ratio, Ensco's ratios indicate that it is a favorable stock to invest in.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seadrill, Transocean And Ensco: Which Is The Best Bet For Now?