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Ensco (NYSE:ESV) operates the world's second largest offshore drilling rig fleet, as well as the newest ultra-deepwater fleet and largest premium jackup fleet. Herein, in my opinion, lies one of the primary advantages ESV holds over industry competitors.

As outlined in the HIS Herold Offshore Contractor Driller's Peer Group Analysis, improved operating margins for offshore drillers are expected in 2014. (An article citing the analysis can be found here.)

Ensco, Noble Corporation PLC (NYSE:NE), and Diamond Offshore Drilling Inc. DO) were cited by the author of the report, John Parry, as companies likely to profit from these trends. According to Parry, the investment in fleet upgrades undertaken by Ensco and Noble should result in a competitive advantage over other contract drillers.

My goal is to identify the best stock in this industry for DGI purposes. The dividend of DO is paltry. While the dividend of NE is better, (2.76%) an investor will lose over a third of the payout due to NE being domiciled in Switerzerland. Consequently, I eliminated NE and DO and will compare Ensco to Seadrill Limited (NYSE:SDRL) and Transocean Ltd. (NYSE:RIG), due to the impressive dividends paid by each company ( 9.55%, 4.62% respectively).

OUTLOOK FOR OFFSHORE OIL EXPLORATION

By 2020, offshore oil production is anticipated to account for 34% of global output, up from 25% in 1990. Deep water drilling efforts should amount to over a third of offshore oil's total contribution. Consequently, demand for ultra-deepwater rigs should increase significantly in coming years.

In 2013, approximately 500 deepwater wells were drilled. In contrast, it is estimated that 1,250 deepwater wells will be drilled in 2025. In 2012, 12 billion barrels of oil equivalent, approximately 57% of all newly discovered ocean oil reserves, were found at ocean depths of 5,000 feet or greater.

At the end of 2012, global ultra-deepwater utilization stood at 99%. This in an industry that considers utilization rates of 85% as more than acceptable. Although ultra-deepwater utilization has declined since then, future demand on those assets should be robust in the future.

Most consultants and company managers anticipate constitutional reform in Mexico. Should that occur, it will result in the breakup of the monopolies on the oil and gas industry and allow opportunities for private capital investment.

Below are charts contrasting Ensco, Transocean and Seadrill.

EARNINGS

EPS (TTM) EPS (FWD) PEG 1 year EPS Growth
ESV 10.1 8.4 0.6 69.44%
RIG 10.5 10.2 0.5 112.52%
SDRL 11.8 11.8 0.4 -21.14%

Financial Strength

Current Ratio Quick Ratio LTD
ESV 1.6 1.4 0.4
RIG 2.0 1.8 0.6
SDRL 0.5 unknown 1.5

Management Effectiveness

ROA ROE ROI
ESV 7.00 10.59 7.37
RIG 4.91 10.51 5.81
SDRL 11.26 36.21 14.36

Although Seadrill excels in several metrics, I eliminated that stock from consideration for the following reasons:

  • Seadrill's dividend payout ration exceeded 100% in 2011 and 2012.
  • Seadrill has only paid dividends since 2010.
  • As noted above, Seadrill is heavily leveraged.

Ensco's management effectiveness metrics exceed Tranocean's in every category. Furthermore, despite Ensco's recent acquisition of Pride International, Ensco has the least long term debt of the three companies. Ensco's dividend coverage of 5.3 indicates an easily sustained dividend. And, last but not least, Ensco paid continuous dividends since 1997. Transocean only began dividend payments in 2011.

ADDITIONAL POSITIVES FOR ENSCO

Ensco's strategy is to position the company as a provider of ultra-deepwater drillships and ultra-premium harsh environment jackups. Ensco sees this fleet composition as the best mix for premium day rates. This should serve Ensco well as global oil supplies become increasingly concentrated in difficult environments.

Ensco was recently recognized by the Oilfield Products and Services Customer Satisfaction Survey as the number one ranking company in their field. Ensco placed first in 10 of 16 categories surveyed. Ensco's floater revenues for the three month and nine month periods ending September 30, 2013 increased by 9% and 14%, respectively. Average day rates for Ensco's fleet increased from $191,260 to $220,731 over the nine months ending in September 30, 2013.

During the second quarter of 2013, Ensco's shareholders approved a share buyback program of $2.0 billion or a maximum of 35 million shares (approximately 15% of current stock). As of January 2013, Ensco had $11.2 billion in backlogged contracts.

Since Ensco is now domiciled in the United Kingdom, Ensco's dividends are not subject to foreign taxation. Owners of Transoceans's stock, however, will have the privilege of paying a 35% tax to the Swiss Republic.

In my estimation, risks associated with this stock are primarily related to the cyclical nature of the oil and gas industry and the possibility of an environmental disaster akin to that of the Deepwater Horizon. However, I believe their modernized fleet lessens the likelihood of direct involvement of Ensco in an event of that nature. Shorter term headwinds are related to an anticipated increase in the supply of drilling rigs.

My technical evaluation of Ensco indicates downward pressure on the stock. My intent is to purchase Ensco on this price dip. I have no doubt that in years ahead I will experience rough patches in this stock associated with the cyclical nature of the oil and gas industry; however, I find that a small price to pay for what appears to be a sustainable dividend and future growth.

Source: Ensco: A Juicy Dividend With Future Growth