Introduction
Ensco (NYSE: ESV) is an offshore drilling contractor headquartered in London, United Kingdom. The company was formerly known as the Blocker Energy Corporation, however, has since changed its name. The company is the second largest drilling corporation in the world with dozens of rigs. The company buys these rigs for hundreds of millions of dollars and then rents them out for a "dayrate" allowing it to earn its revenues and profits.
Ensco has had an incredibly difficult time since the start of the oil crash. The company has watched its stock price go from a peak of more than $55 per share before the start of the crash to recent lows of just over $7 per share, a drop of 87%. However, today, the company's stock went up by almost 10%. But despite this growth, Ensco is still an undervalued company at the present time.
Market Conditions
Market Capex - Ensco Investor Presentation
Oil prices have fallen significantly since the start of the crash, however, oil major capex has fallen even further. Companies tend to be slower about cutting prices once the crash has started, but once the crash gets going they become much more aggressive with their cuts and have them often last much longer. Oil major capex peaked in 2013 at $218 billion and is expected to fall by 45% in 2017 to $120 billion.
The vast majority of these production cuts are occurring in areas that have much higher cost of production. That is, companies will first spend capex on maintaining or additional exploration in fields that have a long history of reliable results before turning to exploring new unproven areas. Since the majority of offshore exploration tends to be expensive and not come with guarantees (as Royal Dutch Shell's recent Arctic drilling program cancellation shows), the offshore drilling market has seen its capex cut even harder.
Oil Market Demand / Supply Overview - HL Financial
There is some bright side, however, the the oil demand / supply market. The oil supply and demand balance first went out of whack in the 3Q 2013 roughly the same time as capex began to fall. However, oil prices started falling in mid-2014 set what was widely viewed as their final bottom in January 2016 and the demand / supply balance is expected to recover by late 2016 meaning a roughly 9 quarter time between the start of the imbalance and its recovery.
Assuming oil prices takes the same amount of time to recover as it took from the start of the imbalance to what is likely its low point in January 2016 that means we can expect it to take another 9 quarters for oil prices to fully require from the late 2016 market rebalancing. Taking this into account, we can expect oil prices to have fully recovered by 2019. At this point, the offshore market should be well on its way to recovery.
Ensco Financial Decisions
Now that we have discussed the market conditions, it is time to discuss the financial decisions Ensco's management has taken since the start of the crash.
Ensco Debt Markets - Ensco Investor Presentation
Since the start of the oil crash, Ensco has accessed the debt markets twice to bolster its liquidity while refinancing the company's near-term debt maturities. Given that as we determined above, the company will need to handle a slump in oil prices that will last until 2019. The company has also extended its revolver to $2.25 billion and 2019 meaning that if companies go bankrupt before prices recover the company can withdraw debt to buy assets.
The company has reduced its capital expenditures and dividend to preserve cash delaying delivery of newbuilds. The company has managed to postpone $0.5 billion of final milestone payments which should allow to save its cash in anticipation of other needs. Currently the use of that cash has been an offering to purchase debt at a market discount helping the company's leverage to be reduced significantly.
However, on the downside, the company has offered equity to increase its cash position which can be used to further reduce its debt. But the company's equity offering at rock-bottom prices hurt investors who have taken a beating since the start of the crash even further. Upon a recovery in oil prices, the increased equity means individual share prices will likely not appreciate by as much.
Despite that, Ensco's overall financial decisions since the start of the crash have been very impressive.
Ensco Liquidity and Debt Ratio - Ensco Investor Presentation
This next image shows how much Ensco's liquidity and debt-to-capital ratio have improved. Over the past two quarters, the company's debt-to-capital ratio has improved by 13% points (fell by a factor of one-third). At the same time, the company's liquidity has increased significantly as the company's revolver has stayed the same while the company's cash + short-term investments has increased by $0.5 billion mainly resulting from the company's debt offering.
Ensco Debt Schedule - Ensco Investor Presentation
Another thing to keep in mind is that Ensco's impressive financial improvement ($0.5 billion in additional cash) have come on top of the $0.94 billion in debt the company has purchased from 2019 until the 2025 period. The company has no debt maturities due until 2019 (when we determined oil prices were likely to have recovered by).
And let's look at a worst case scenario where the oil crash gets dragged on for a long time. The company's $1.8 billion of cash is enough to purchase its debt due until 2023. Should the crash last past that, the company's 2024 - 2027 debt amounts to $1.5 billion. That means the company has a decade from this point to repurchase $1.5 billion in debt, or just $0.15 billion in annual debt repurchases.
Repurchasing this debt could allow the company to survive until 2040 before any debt is due.
Expense Outlook
Now that we have an overview of Ensco, followed by the market outlook, and the very impressive financial decisions Ensco has taken since the start of the crash, it is now time to discuss the company's expense outlook.
Ensco Expense Reduction Actions - Ensco Investor Presentation
In 2015, the company managed to reduce its offshore until labor costs by 15% and expects $60+ million in annual savings from its reduction of onshore support headcount. The company anticipates an additional $100 million in contract savings and along with its recent actions, the company saw its contract drilling expenses drop to $350 million in the most recent quarter 36% since the start of the crash.
Ensco Rig Cost Reductions - Ensco Investor Presentation
Another way Ensco can save money is by stacking its rig. The above image provides an overview of the company's rig types along with the upfront cost to preservation stock and the estimated savings from reactivating. While stacking a rig and reactivating it is very expensive, the company's daily expenses go down significantly.
For a drillship, the rig needs to be stacked for roughly 4 years for the cost savings to make back the total costs of stacking and reactivating. For the 7500 series semi that goes to 5 years and for the company's high-spec jackups, that goes down to just over a year. As a result, based on these figures, the company needs to be much more focused on stacking its high-spec jackups as opposed to its other ships.
This combination of reducing costs and managing finances shows Ensco's impressive potential as an offshore driller.
Conclusion
Ensco has had an incredibly difficult time watching its stock price drop by almost 90% from the start of the oil crash. The company has been forced to cut its dividend to almost nothing and issue equity in order to keep its financial position strong in the face of a long draw out oil crash that could last several years longer as a minimum.
However, the company's decisions have placed it in an incredibly position. The company now has enough cash on hand to purchase all its debt until 2023 and has no debt due until 2019. The company has managed to purchase almost $1 billion in debt back so far and has a $2.25 billion revolver that will allow the company to purchase additional debt or make an acquisition should it want to. The company has managed to rapidly decrease its costs from the start of the crash by almost 40%.
The company's impressive financial decisions and cost improvements show how Ensco is a strong investment at the present time.
