Is Ensco Heading To New Lows?

Summary

• Ensco's Q4 results are somewhat disappointing.
• Moreover, earnings call comments are surprisingly cautious.
• While the company's shares have already been punished severely for the acquisition of Atwood, a further decline in oil prices might lead to new lows.

Earlier in February, I wrote an article about my expectations for at least a technical rebound in offshore drilling stocks. I was generally positive on major offshore drillers, but was cautious on Ensco (ESV). Here's what I wrote at that time:

Ensco's shares are once again paying the price for the acquisition of Atwood Oceanics, an aggressive bet that always puts pressure on the stock during the downside. As a result, Ensco's shares are not that far from lows once again. It will be very interesting to hear what Ensco's management team has to say when the company reports its quarterly results on Feb. 27. So far, the market is clearly unimpressed.

Now that Ensco has published its fourth-quarter results and has held its earnings call, it's high time to look at the company again, especially in the light of the recent trading action:

Let's quickly get through the headline numbers. In the fourth quarter, the company had an adjusted loss of $0.23 per share on revenue of $454.2 million. This had to be expected: Better-era contracts run out and they are replaced by new contracts, which are in many cases near cash breakeven. The GAAP loss was even bigger at $0.49 per share, influenced by a $183-million impairment.

As per the company's comments, the impairment charge primarily relates to changes in useful life assumptions for two non-core floaters. This announcement is a stark reminder to anyone willing to use "discount to book" as an argument for or against investment in an offshore drilling company today. Book value means nothing today unless it comes from fresh-start accounting, like in Ocean Rig's (ORIG) case.

Ensco finished 2017 with $885.4 million in cash and short-term investments on the balance sheet. This is a great decrease from $2.6 billion in cash that it had at the end of 2016. The main reason for this change is the acquisition of Atwood Oceanics. I've been critical of this decision right from the start, as it increased the risk for Ensco. The market is in agreement with my position - Ensco's shares underperform its peers and are currently heading to new lows.

Ensco stated that it paid $207 million for jackup Ensco 123 in January, but the rig will be delivered in the first quarter of 2019. Newbuild payments for Ensco DS-13 and Ensco DS-14 (Atwood newbuild rigs) are $250 million, excluding interest and holding costs. In my opinion, while not putting Ensco at a survival risk, these payments are also of concern to the market. The recent debt deal improved the maturity schedule and increased available cash (the liquidity number on the picture below from Ensco's presentation is adjusted to reflect the debt offering and the subsequent tender offers):

Interestingly, Ensco's comments during the earnings call were much less optimistic than Transocean's (RIG). The company expects a protracted and phased recovery, and seems to be cautious about work in 2018 while being more optimistic on 2019. The top priorities remain to employ drillships DS-9 and DS-11. The ultra-deepwater drillship segment remains in a challenging state, so this will be a tough task assuming Ensco does not want a contract below cash breakeven.

While Ensco is not heading into any kind of a financial catastrophe in the near term, this year will be a tough one for the company from an earnings point of view. The company even commented during the earnings call that market observers were being too optimistic on the revenue side for Ensco. Obviously, this is not commentary the market wants to hear, especially given the fact that losses are expected for the next few years:

Source: Yahoo Finance

Going forward, I expect that Ensco shares will be highly volatile and will present many trading opportunities. Those willing to invest in Ensco for the long term at admittedly low prices should be prepared to stomach many ups and downs. The legacy of the Atwood acquisition makes Ensco more interesting than its peers on oil upside (especially if oil climbs above $70 and we start to see new contracts at healthier rates in the floater space), but it makes the company more vulnerable on the downside.

If Brent oil (BNO) dips below $60, I'd fully expect to see Ensco shares at new lows regardless of whether it's fundamentally justified. Should such a dip be significant, it will create a great buying opportunity - if you share the thesis that Ensco will survive the market downturn with the current capital structure.

Analyst’s Disclosure: I am/we are long RIG. 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.

I may trade any of the above-mentioned stocks.