Ensco Offers A Compelling Buy At Today's Levels

Aug. 7.12 | About: Ensco PLC (ESV)

Ensco (ESV), the second largest offshore drilling company in the world, announced its second quarter results on July 25, 2012. The company more than doubled its net income from the prior year quarter, due largely to its May 31, 2011 acquisition of Pride International. This resulted in three months of earnings from the rigs obtained in this acquisition being reflected on the latest quarter's results compared to one month of earnings from these rigs being reflected on the prior year quarter's results. The acquisition was not the only factor that was behind the higher earnings, however. Ensco would have reported significant year over year growth without the additional of revenues from the acquired Pride rigs. This speaks towards the strength in the offshore drilling market that exists today. Here are the highlights from Ensco's second quarter.

  • Revenues in the quarter were $1.072 billion. This is an increase of 90.07% from the $564 million in revenues that Ensco had in the prior year quarter. Excluding the effects of the acquisition, revenues increased 44% over the prior year quarter.
  • Contract drilling expense was $490 million for the quarter. This is an increase of 41.6% from the prior year quarter. Excluding the effects of the acquisition, contract drilling expenses increased by 37% compared to the prior year quarter. Ensco attributes these increased costs to increased rig utilization and higher labor costs.
  • The company reported net income of $341.3 million, up 234.9% from the $101.9 million that the company earned in the prior year quarter.
  • Ensco reported diluted EPS of $1.47 per share compared to $0.59 per share in the prior year quarter. This represents an increase of 149.15% over the prior year quarter.

Ensco saw strong growth in its deepwater drilling segment. Long-time readers know that I have discussed the strong and improving fundamentals in the deepwater and ultra-deepwater markets (most recently here) and these results provide further validation of these convictions. Ensco's revenues from its deepwater segment increased to $572 million. This compares quite favorably to the $232 million that this segment brought in during the year-ago quarter. The segment still showed strong growth even if we exclude the effects of the Pride acquisition. Excluding these rigs, Ensco's deepwater segment grew revenues by $93 million. This is a 71% increase from the prior year quarter. This increase was largely due to the addition of the ENSCO 8504 to the company's fleet and the ENSCO 7500 performing active contract work.

This active contract work causes the rig to generate revenue for Ensco instead of sitting in a shipyard and earning nothing. The rig began its work under the current contract with Petrobras (PBR) in the third quarter of last year. The contractual dayrate for the rig is $320,000. Brazil, which is where the rig is currently operating, typically carries higher dayrates than other areas such as the Gulf of Mexico. This is indicative of a concern that I have regarding Ensco: the company does not typically earn good dayrates on its rigs compared to some of its competitors. For example, two months after this contract was announced by Ensco, SeaDrill (SDRL) announced a five-year contract in the Gulf of Mexico at an average dayrate of $465,753. The first two years, which are going to be the cheapest, have an assigned dayrate of $465,000.

In my analysis of SeaDrill's first quarter results, I criticized Ensco's utilization rates relative to SeaDrill. I am pleased to see that Ensco has made great improvements in this area over the last quarter. The company's utilization rate for the deepwater segment increased five percentage points to 91% in the second quarter. Excluding the effects of the Pride acquisition, utilization increased six percentage points to 89%. The utilization rate for the company's 8500-series of rigs was even better at 96% for the quarter. Higher utilization rates have a positive impact on revenues, cash flows, and earnings so any improvement in this area is ultimately beneficial for the company. Ensco's management suggested in the company's earnings conference call that utilization rates will likely improve even further going forward. This will have a positive impact on the company's bottom line growth.

At the end of May, I wrote an article entitled, "A Bullish Case for Ensco." In that article, I stated that the jack-up market is strengthening and that this could lead to growing profits for Ensco. These quarterly results have provided validation for that thesis. The company's jack-up segment revenues grew 31% from the prior-year quarter, increasing to $378 million. This revenue increase was driven by a $6,000 increase in the average dayrate and an eight percentage point increase in the utilization rate. This increased the jack-up utilization rate to 83%, or 92% excluding the effects of the acquisition. A 83%, or even a 92%, utilization rate is well below what competitors such as SeaDrill have managed to achieve in recent quarters but both figures are much improved from the first quarter and show that Ensco is moving closer and closer to achieving its full potential.

Ensco looks likely to continue to grow its business in the coming quarters. The company recently took delivery of the ENSCO 8506. This is the final ultra-deepwater semisubmersible in the company's highly successful 8500-series of rigs. The ENSCO 8506 has already been contracted out to Anadarko (APC) for work in the Gulf of Mexico beginning in December. The rig has been awarded a dayrate in the low $530s. Thus, revenues and profits will begin to show the impact of the rig beginning in the fourth quarter. It is the first quarter of 2013 that will really show the effects of this rig, though, as it will be operating and generating revenues for the entire quarter. In addition, the company has six more rigs under construction. Three of these are ultra-deepwater drillships and the remaining three are jack-up rigs. These newbuild rigs will generate additional revenues, profits, and cash flows for Ensco as construction finishes and the rigs leave the yard. This newbuild program is not as aggressive as Ensco's smaller competitors SeaDrill and Noble Corp (NE). Both of these companies (particularly SeaDrill) have the potential for stronger earnings growth from newbuilds while Ensco is adopting a more conservative attitude towards its growth.

Ensco announced on July 26 that it will be joining the S&P 500 index. The company officially joined the index after the close of business on Monday, July 31. This will, and likely already has, create a large amount of new demand for the company's stock. This demand will come from the enormous amounts of money in index funds and ETFs that track the S&P 500 index such as the SPDR S&P 500 ETF (SPY). These funds will likely be forced to get exposure to Ensco to fulfill their investment objective of matching the return of the S&P 500 index. The opportunity to profit from this has already passed, however.

Ensco's stock has seen a huge run up in the past month.

ESV Chart

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Despite this, the company still offers a compelling buy at present levels. Earlier in this article, I described how rising utilization rates could benefit Ensco's bottom line. Additionally, if Ensco manages to bring up its dayrates, this would have an enormous impact on the company's cash flows, revenues, and profit. Ensco's average dayrate in its deepwater segment is $390,000 while the worldwide fleet average is $466,000 for drillships and $415,000 for semisubmersibles. If Ensco can bring its fleet average up to that level, then that would represent tens of thousands in additional revenue for every rig each and every day for the company. This additional revenue would be almost entirely profit as the company's operating expenses would not increase. According to Zack's Investment Research, analysts expect Ensco to earn $5.33 per share this year and $6.98 per share next year. This gives the stock a PEG ratio of approximately 0.68 at current prices. While the stock appears to be a good buy at today's prices, potential investors may be presented with an even better opportunity in the form of a pullback over the next few weeks.

Disclosure: I am long SDRL.