Ensco Plc: 10% Undervalued With Significant Growth Ahead

Nov.11.13 | About: Ensco PLC (ESV)

For investors looking for a mid-cap company in a sector poised for growth, Ensco PLC (NYSE:ESV) is a growth-oriented, offshore oil and gas drilling company with many catalysts that will increase shareholder value.

Ensco plc is a global provider of offshore drilling services to the petroleum industry. Operating across six continents, the company's high-quality fleet (existing and under construction) includes 10 drillships, 13 dynamically-positioned semisubmersibles, 6 moored semisubmersibles and 46 premium jackups. In addition, the company provides drilling management for three customer-owned deepwater rigs. Ensco's rigs have drilled some of the most complex wells in virtually every major offshore basin around the globe.

On May 31st, 2011 Ensco plc acquired Pride International Inc. With this acquisition Chairman and CEO Dan Rabun stated, "Today is an important milestone in Ensco's history. Through this transaction, we have expanded our deepwater fleet with drillship assets, and now have a substantial presence in Brazil and West Africa - both strategic, high-growth markets. In addition, we have gained major new customers from around the world.

At the time the Pride acquisition looked to be a positive move. In the section below, I will analyze aspects of Ensco's past performance and aspects of this acquisition. From this evaluation, we will be able to see Ensco's profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $1.697 billion
  • Net income 2011 = $2.843 billion
  • Net income 2012 = $4.301 billion
  • Net income 2013 TTM = $4.750 billion

Over the past three years Ensco's net profits have increased from $1.697 billion in 2010, to $4.750 million in 2013 TTM. This represents a 179.90% increase.

ESV Revenue (NYSE:<a href='http://seekingalpha.com/symbol/TTM' title='Tata Motors Limited'>TTM</a>) Chart

ESV Revenue (TTM) data by YCharts

  • Operating income 2010 = $626 million
  • Operating income 2011 = $794 million
  • Operating income 2012 = $1.565 billion
  • Operating income 2013 TTM = $1.692 billion

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years Ensco's operating income has increased from $626 million to $1.692 billion in 2013 TTM. This represents an increase of 170.29%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage.

  • Net income growth

    • Net income 2010 = $1.697 billion
    • Net income 2011 = $2.843 billion
    • Net income 2012 = $4.301 billion
    • Net income 2013 TTM = $4.750 billion
  • Total asset growth

    • Total assets 2010 = $7.052 billion
    • Total assets 2011 = $17.871 billion.
    • Total assets 2012 = $18.565 billion.
    • Total assets 2013 TTM = $19.143 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 4.16%.
    • Return on assets 2011 = 6.29%
    • Return on assets 2012 = 4.32%.
    • Return on assets 2013 TTM = 4.03%

Over the past three years Ensco's ROA has decreased from 4.16% in 2010 to 4.03% in 2013 TTM. This indicates that the company is generating less income off its assets than it did in 2010.

ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2010 - $1.697 billion / $5.960 billion = 28.47%
  • 2011 - $2.843 billion / $10.879 billion = 26.13%
  • 2012 - $4.301 billion / $11.846 billion = 36.31%
  • 2013 TTM - $4.750 billion / $12.593 billion = 37.72%

Unlike the ROA, the ROE is showing a significant improvement. Since 2010 the ROE has increased from 28.47% to 37.72%. As the ROE has increased over the past four years, this reveals that there has been an increase in how much profit has been generated compared to the amount that shareholders have invested, thus indicating an increase in shareholder value.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $7.052 million
    • Total assets 2011 = $17.871 billion.
    • Total assets 2012 = $18.565 billion.
    • Total assets 2013 TTM = $19.143 billion.
    • Equals an increase of $12.091 billion
  • Total liabilities

    • Total liabilities 2010 = $1.092 billion
    • Total liabilities 2011 = $7.019 billion
    • Total liabilities 2012 = $6.718 billion
    • Total liabilities 2013 TTM = $6.549 billion
    • Equals an increase of $5.457 billion

Over the past three and a half years, Ensco's total assets have increased by $12.091 billion, while the total liabilities have increased by $5.457 billion. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $1.436 billion
    • Current assets 2011 = $1.681 billion
    • Current assets 2012 = $1.723 billion
    • Current assets 2013 TTM = $1.517 billion
  • Current liabilities

    • Current liabilities 2010 = $349 million
    • Current liabilities 2011 = $1.332 billion
    • Current liabilities 2012 = $989 million
    • Current liabilities 2013 TTM = $940 million
  • Current ratio 2010 = 4.11
  • Current ratio 2011 = 1.26
  • Current ratio 2012 = 1.74
  • Current ratio 2013 TTM = 1.61

ESV Current Ratio (Quarterly) Chart

ESV Current Ratio (Quarterly) data by YCharts

Over the past three and a half years, Ensco's current ratio has decreased. As the current ratio is well above 1, this indicates that Ensco would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 285 million.
  • 2011 shares outstanding = 230 million.
  • 2012 shares outstanding = 232 million
  • 2013 TTM shares outstanding = 234 million

Over the past three and a half years, the number of company shares has decreased from 285 million to 234 million.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $932 million / $1.674 billion = 55.67%.
  • Gross margin 2011 = $1.348 billion / $2.797 billion = 48.19%.
  • Gross margin 2012 = $2.272 billion / $4.300 billion = 47.85%.
  • Gross margin 2013 TTM = $2.438 billion / $4.748 billion = 51.35%.

Over the past four years, Ensco's gross margin has dropped slightly. The ratio has decreased from 55.67% in 2010 to 51.35% in 2013 TTM.

ESV Gross Profit Margin (Quarterly) Chart

ESV Gross Profit Margin (Quarterly) data by YCharts

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $1.674 billion
    • Revenue 2011 = $2.797 billion
    • Revenue 2012 = $4.300 billion
    • Revenue 2013 TTM = $4.748 billion
    • Equals an increase of 183.63%.
  • Total Asset growth

    • Total assets 2010 = $7.052 million
    • Total assets 2011 = $17.871 billion.
    • Total assets 2012 = $18.565 billion.
    • Total assets 2013 TTM = $19.143 billion
    • Equals an increase of 171.45%.

Over the past three and a half years the revenue growth has increased by 183.63% while the assets have increased by 171.45%. This is an indication that the company from a percentage point of view has been more efficient at generating revenue.

Based on the information above we can see that Ensco has produced strong results from a fundamental point of view. Revenues over the past three and a half years, have increased by 183.63%, the ROE has increased from 28.47% to 37.72% in the same time period. The company's revenues have increased more than the assets indicating the company is more efficient at generating revenue with its assets. The only notable blemish on the company is that the gross margin has dropped from 55.67% to 51.35% but a gross margin over 50% is still very respectable. Based on the results above we can see that the Pride acquisition has helped produce strong results.

Global Demand for Offshore Drilling

Over the next four years, it is estimated that global growth in the offshore E&P sector will increase at an 8% to 10% compound annual growth rate. With spending estimates in the range of $250 billion on the development of their offshore reserves, Brazil is leading the way. Second to Brazil in E&P spending is Norway, which is anticipating $220 billion to be spent on the development of the North Sea, Norwegian Sea, and the Barents Sea while estimates are that U.S. Gulf Of Mexico E&P spending is expected to be around $190 billion over the next four years. Just within these three regions, estimates total $760 billion in E&P spending over the next four years. From a global point of view this bodes well for Ensco plc.

Capacity Concerns in the Offshore Drilling Market

Even though the offshore drilling market is expected to grow significantly over the next four or five years, capacity is an issue of concern to investors. The issue of capacity is of concern to all companies in the offshore drilling industry including investors in Ensco's competitors Seadrill inc. (NYSE:SDRL), Transocean (NYSE:RIG) and Noble Corporation (NYSE:NE).

In an article published by Barrons they issued a statement about the capacity issue"

As the industry is expected to add 20 new rigs, or 16%, in 2013, 21 new rigs, or 14% in 2014 and 13 new rigs, or 7.8% in 2015, Sedita believes the new rigs are creating a "potential for short-term bubble." Sedita writes:

We believe there could be potential near-term excess capacity for ultradeepwater rigs in 2014 given a substantial number of newbuild rigs entering the market in a short span of time, as well as a bit sluggish demand in some regions (Brazil, West Africa). Long-term we believe demand is strong and the market will absorb the rigs over time. In the near-term we believe all of the ultradeepwater newbuilds will find contracts; however, dayrates will likely remain flat over the coming years and we see no rate upside. The risk to utilization and dayrates is in the lower-specification mid-water and deepwater markets. We believe over the near-term that some of these lower specification rigs could see idle time between contracts and a bit softer dayrates.

As the charts below indicates the capacity issue has been reflected in the companies stock prices. As you can see the sector has underperformed the S&P significantly.

As the offshore drilling market continues to expand and the market absorbs the incoming rigs this should increase dayrates and utilization rates in the future. As these rates increase so should the companies margins thus increase shareholder value.

Analysts' Estimates

Analysts at MSN Money are estimating an EPS for FY 2013 at $6.33 while growth is expected to continue into 2014 as EPS estimates increase to $7.38.

Valuation

In the section below, I will use a couple of different methods to find a valuation of the stock price. In this section, I will use the Discounted Cash Flow valuation model and forward P/E ratios to estimate the current value of each share.

I believe using the Discounted Cash Flow valuation model for Ensco plc to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.

Click to enlarge

Even though there are variations in calculating this formula, this model is based off of a terminal value of $22.660 billion and a WACC of 7.28%. The terminal value $22.660B is based off of the company trading at a very conservative 10X EBITDA. Using these valuations, I have concluded Ensco's present value to be $64.58 per share.

Conclusion

Because of Ensco plc's management making a key acquisition in May 2011, Ensco is set-up nicely to capitalize on a offshore drilling boom. Even in the face of over-capacity, Ensco is still posting very strong fundamentals, and is poised to capitalize on future growth in the industry. Even though the stock price has increased over the past few weeks, I believe the company is still trading at a discount. Based on the DCF analysis, I believe the current fair price for the stock is $64.58 which offers a discount of 9.52%.

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.