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Summary

  • Ensco looks attractive at current levels on a standalone basis and relative to Seadrill.
  • The company will continue to increase dividends at a robust pace as new rigs become operations.
  • Low leverage and attractive valuations are the other positive factors for Ensco.

Ensco (NYSE:ESV), which provides offshore contract drilling service to the oil & gas industry, is an attractive investment option to consider at these levels. This article elaborates on this conclusion and discusses the factors that make Ensco an attractive stock to buy and hold.

Big Pipeline Of New Rigs

Ensco has eight new rigs to be delivered by 2016. This includes one rig to be delivered in 3Q14, three rigs to be delivered in 1Q15, one rig to be delivered in 3Q15 and the remaining three rigs to be delivered in the second half of 2016.

With the delivery of three drillships and five premium jack-ups, Ensco is well positioned to show strong revenue growth in 2015, 2016 and 2017. Also, the company's average rig age will decline significantly once all these rigs are delivered through 2016. Ensco's new ultra deep-water fleet (≥ 7,500') are already among the youngest in the industry with an average age of 4 years. This is just behind the average age of 3.4 years for Seadrill's (NYSE:SDRL) fleet.

Another positive factor related to the new rigs is the current contract status. As of June 2014, one premium jack-up to be delivered in 2014 and two drillships to be delivered in 1Q15 have already been contracted. As more of the new rigs are contracted, Ensco's stock will move higher as it makes revenue visibility firm. In my opinion, it will not be difficult to contract the modern fleet as the market conditions are challenging, but not depressed.

Growing Dividends

Ensco's current dividend payout is $3 per share and the company offers a dividend yield of 5.4%. The dividend yield is not as attractive as Seadrill, which offers a dividend of $4 per share and a dividend yield of 10%.

However, Ensco's dividends are growing at a steep pace and I believe that the company's dividends will continue to increase. From a dividend payout of $0.1 per share in end-2009, the company's dividend per share has increased to $3 per share.

As eight new rigs are deployed into operation in over the next 2.5 years, the dividend per share is likely to grow at a healthy pace. Investors seeking strong dividends can consider Ensco as a good investing option.

Investors might argue that Seadrill offers a dividend yield of 10% and Ensco offers a dividend yield of just 5.4%. I would say that it depends on the risk appetite of investors. As of March 2014, Seadrill had a leverage of 65% and Ensco had a leverage of just 27%.

In my opinion, Seadrill's leverage is also not a concern, but there are investors who will avoid Seadrill because of the company's leverage. For those investors, Ensco is an exciting investment opportunity.

Another factor that investors might not like about Seadrill is that the company's payout ratio (quarterly dividend annualized divided by EPS estimate) is 122% as compared to just 53% for Ensco. Seadrill might be stretching too much on dividend payments while Ensco has room to increase its payout in the future.

High Financial Flexibility

Ensco needs nearly $2.6 billion over the next 2.5 years to fund the new rig program. Of the total cost, nearly $2.4 billion will be due in 2014 and 2015. Ensco is very well placed to fund the new rig program with a leverage of just 27% as of March 2014.

In addition, Ensco also reported an operating cash flow of $990 million for the first half of 2014. A capital expenditure of $632 million for the first half of 2014 means that the company is FCF positive for 1H14. Also, the operating cash flow for the second half of 2014 should be stronger with one new rig for delivery in 3Q14.

Even if Ensco generates close to $2 billion in cash flow for 2014 and $2-$2.5 billion in cash flow for 2015, the company's internal funds will be sufficient to pay for the delivery of new rigs. Ensco might go for debt funding if the terms are attractive. In any case, the company's net debt position will not be stretched after the delivery of eight new rigs by 2016.

In comparison, Seadrill has a debt of $12.3 billion and debt would increase to $18-$20 billion after delivery of new rigs over the next 2-3 years. I am not suggesting through these points that my outlook for Seadrill is negative. However, on a relative basis, Ensco looks good with strong growth coming for the company.

Another aspect of the company's financial flexibility is the sale of oil rigs. Since 2009, Ensco has sold 14 rigs for a pre-tax gain of $90 million. This is a good strategy as the company's financial flexibility increases and the overall fleet is also more modern. I believe that over the next 2-3 years, Ensco might continue to sell old rigs at attractive prices and replace old rigs with a modern fleet. This will keep the leverage in check.

Conclusion

Besides all the positives discussed, Ensco also trades at attractive valuations and this is another reason to consider exposure to the stock at current levels. Ensco currently trades at an EV/EBITDA of 6.76 as compared to an EV/EBITDA of 11.91 for Seadrill.

It is likely that the valuations for Ensco will catch up with Seadrill over the next 2-3 years. Seadrill does deserve some premium valuation at this point with an overall fleet that is more modern than Ensco. However, when eight new rigs are delivered by 2016, Ensco will certainly match up with Seadrill's valuation.

The investment horizon is therefore long-term and investors need to hold the stock for at least 2-3 years for the full story to unfold. Over the next 2-3 years, the dividend payout by Ensco will be much higher and investors are likely to get the double benefit of high dividends and capital appreciation.

Source: Ensco Looks Attractive At Current Levels