How To Earn A Higher Than 10% Annual Return With Ensco

| About: Ensco PLC (ESV)

Summary

The bonds of Ensco currently offer an annual return 12%-14%.

While many things should go right for a stock to offer great returns, bonds require only one condition; that the company does not go bankrupt.

Ensco has the second-best credit rating among the offshore drillers. There are no debt maturities until Q2-2019.

Investors are well aware that stocks can offer much more exciting returns than corporate bonds, albeit at a higher risk. However, there are some extraordinary cases, in which the bonds of a company offer a much better risk/reward profile than the stock. Ensco (NYSE:ESV) currently seems to be such a case. While the stock has plunged 80% from its peak almost 2 years ago, investors should realize that its bonds offer an annual yield of about 12%-14% for the next 5-9 years, depending on the class of bonds chosen (data from Morningstar.com).

Bond

Maturity date

Amount

Price

Coupon

% Yield to maturity

Ensco 5.75%

10/1/2044

1,025.0

50.1

5.750

11.93

Ensco 4.7%

03/15/2021

857.5

66.6

4.700

14.38

Ensco 0.09%

03/15/2025

669.3

54.3

5.200

14.48

Ensco 3%

10/1/2024

623.3

58.4

4.500

12.64

Ensco Intl 7.2%

11/15/2027

148.9

58.1

7.200

14.90

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While many things should go right for a stock to offer great returns, bonds require only one condition; that the company does not go bankrupt. Investors should take this factor into account when they find bonds that offer exceptional returns, even higher than the long-term returns of the stock market. Great opportunities may arise when a whole sector is beaten due to adverse conditions. This is currently the case with the companies that provide offshore drilling services, such as Ensco. The whole sector has been severely affected by the collapse of the oil price and the prices of all the stocks and corporate bonds have been decimated indiscriminately.

Investors should realize that only the financially weakest companies may go out of business while the healthiest ones are likely to navigate through the oil crisis. As the graph below shows, Ensco has the second-best credit rating among the offshore drillers. The management is quite conservative and essentially eliminated the dividend this year. While this may not bode well from the shareholders, it is a favorable move for the bond holders. The management has also maintained a relatively healthy balance sheet, with a current ratio of 3 and a cash reserve of $1.3B. In addition, there are no debt maturities until Q2-2019. The company has also secured revenue backlog of $5.8B, worth the revenue of 1.5 years, and is expected to earn about $500M this year and $200M in 2017. Therefore, Ensco seems to be well protected for the current oil crisis and is likely to be the last offshore driller to go out of business.

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It is also reasonable to assume that the excessive cuts on capital expenses by the oil producers will start to take their toll on the supply of oil in the near future. More specifically, the capital expenses of oil producers have halved in the last 3 years, from $292B in 2013 to $149B (expected) this year. Therefore, the price of oil is not likely to remain around its current level for more than 1-2 years. Consequently, when the bonds of Ensco start to mature in 3 years from now, the oil market will probably be in a much better shape than it is now.

The only point of concern is the fact that many new floaters and jackups are currently under construction and will soon find their way into the market. More specifically, the number of the upcoming new floaters and jackups is about 25% of the current active fleet, which cannot be ignored by any means, particularly given that the market is already oversupplied. However, a similar number of floaters and jackups is likely to be retired in the next 2 years due to their age and the efforts of the offshore drillers to minimize their operating costs. Therefore, the total number of floaters and jackups is not likely to significantly increase in the near future.

All in all, the bonds of Ensco have been beaten indiscriminately, along with the bonds of all the other offshore drillers. However, thanks to its relatively strong balance sheet, its superior credit rating, and its conservative management, Ensco is likely to be the last offshore driller to go out of business. Therefore, its bonds, which offer an exceptional annual yield, about 12%-14%, have a highly attractive risk/reward profile. Given the high risk of the stock, the risk/reward profile of the bond seems to render them a superior investment choice under the current circumstances.

Disclosure: I/we 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.