Ensco International Q1 '08 Performance Review

Summary of Ensco's (ESV) Q1 2008 results (all US$ unless noted):

• Operating cash flow dropped 45.9% to $151.2M. A large portion of this stemmed from the $83M of auction rate securities [ARS], which were originally intended for short-term liquidity needs, being transferred to long-term investments and not available for working capital. Backing out this one-time event, OCF was down 16% YOY. The company also mentioned higher tax payments and contract drilling expenses in its 10Q footnotes.
• Balance sheet still looks rock-solid. Ensco is carrying its ARS securities at $74.9M but has the ability to hold onto them until maturity. With $665M in cash, working capital should be fine. Shares outstanding are 5% lower from last year.
• Income statement turned in nice results with top-line growth up 13% and net income up 17% — both outpace the 12% rise in operating expenses. Operating & net margins are up slightly to 56.76% & 46.87% respectively. The company benefited from a lower 19% tax rate, which was due to more income being generated in regions with favorable tax treatment. This lower tax rate seems to be sustainable going forward.

Other items of note:

• Jackup rig day rates and revenues were up across all regions except for the Gulf of Mexico [GOM]. The North Sea market remains tight while Asia Pacific is holding up despite new-build supply coming into the market. GOM rates are stabilizing as demand picks up and more rigs leaving the region.
• The company has announced intentions to build another semi-submersible rig, ENSCO 8504, for delivery in latter-half 2011 at an expected cost of $515M. The company anticipates having this rig contracted well before completion date.
• Management expects a definitive contract in place for ENSCO 8503 at terms of $510k per day for two years.
• The timeline for the first 8500-series semisub, ENSCO 8500, has been pushed back again, from the original Q2 2008 date to Q4 2008 last quarter and now to Q1 2009. The company reasserted the schedules for the ensuing 8500-series rigs, stating that working out the kinks on the first rig will enable smoother delivery in the future.

2008 Guidance

• shipyard days @ 63 for ENSCO 93 upgrade (this is already completed as of now)
• contract drilling expense +15%
• depreciation @ $200M, G&A ~ $53-54M and tax rate @ 18%
• CapEx increased to $680M due to 8504 order
• Q2 2008 — revenues +6% from Q1; contract drilling expenses up 10-12%; tax rate @ 18%

Ensco International reported good results and addressed some possible concerns.

Obviously, the delay on the ENSCO 8500 is a minor hit as it defers additional deepwater drilling revenue into the next fiscal year. While it’s understandable that the first machine in a new line will experience some “teething” problems, management should be held to their word that the following rigs in the series meet the timelines unless Keppels messes up on their end.

CEO Daniel Rabun also sought to alleviate concerns of softening international day rates due to new supply coming online. Rabun asserted that only 8 out of 31 international jackup rigs were exposed to rate repricing, 6 of them in 2009. The North Sea continues to look good while the 10 of the 11 rigs in Saudi Arabia, New Zealand and Venezuela are expected to reset to the upside.

GOM may be picking up and Ensco has about a third of their fleet in that region.

Overall, Ensco turned in a good quarter but there are some questions lingering for the future. They were unsuccessful on their Pemex bids and expressed reticence about aggressively bidding into that market with incumbent operators and fussy specs. Contract drilling expense will continue to factor prominently as it’s projected to rise 15% this year, possibly outstripping revenue and earnings growth. Operating cash flow, even after backing out the one-time hit of the ARS, is running a little lower than I’d like to see. ESV also failed to return cash to shareholders via share buybacks or a dividend hike in Q1 08 as they announced the construction of a new 8500 rig.

Here are my performance measurements going forward:

• Hit guidance — especially on contract drilling expense and shipyard days.
• Generate top+bottom line growth of 10+% in 2008.
• Maintain or build on the current $3.8B backlog as of YE 2007.
• OCF run rate to revert back to 2007 levels (~40-50% of revenues or so, Q1 08: 26%) .
• Slight tailwind in international markets as outlined by Rabun, stabilization in GOM and new entries into Iran, UAE, etfc.
• Hold the line on 8500 series roll-out:
  • 8500 pushed back to Q1 2009
  • Scheduled for 08/01/2008
    • 8501 main engine startup
    • launch of 8502 pontoons
    • keeling of 8503

Disclosure: Long

Comments

[Tondog]

Time delays, 8500s

I would not be surprised to see additional delays on the other 8500s, these are big complicated machines and although Keppels is one of the most compitent yards in the world these projects almost always have "optimistic" projections. Normally upper level management sets the timeline then the project managers and engineers get tasked with trying to meet it. Put another way, I've yet to ever see a large shipyard new build meet an original estimate. This being said if anyone where to have a chance it would be Ensco / Keppel.

Tony