Ensco: Cut It A Little Slack (NYSE:VAL)

21.65K Followers

Summary

Total revenues declined to $454.2 million from $504.6 million in the year-ago quarter. However, we notice that a revenue stabilization driven by a nascent recovery is shaping up as evidenced by the recent fleet status.
The company is putting in place a firm defensive financial position while waiting for a recovery, by reducing costs and re-organizing its debt and liquidity.
A cautious accumulation on any weakness at $4.50 or below for investors who own already ESV seems a possible strategy.

Ensco PLC - Semi-submersible Ensco 5005: Design: F&G L-1033 Enhanced Water Depth: Midwater: 1,000' - 4,499'.

Investment Thesis

Ensco PLC. (ESV) is one of my long-term offshore drillers, and I am still confident the company will survive these severe and everlasting headwinds. Market capitalization is $1.94 billion (as of March 2018), which qualifies the company as a mid-cap stock.

ESV is a very volatile stock and should be considered a useful trading tool only, due to the uncertainty surrounding the oil prices at the moment and the potential effect of the merger with Atwood.

I recommend ESV as a long-term hold until we can figure out the real effects of the Atwood acquisition, which continues to worry me. A cautious accumulation on any weakness at $4.50 or below for investors who own already ESV seems a possible strategy.

A simple look at the fleet status and the fourth quarter results is very telling. We are experiencing an offshore drilling recovery supported by oil prices above $60 per barrel. I recommend reading my preceding article about Ensco's February fleet status.

The caveat lector is that the day rates and profit margin are extremely low in order to entice oil majors and O&G companies to drill offshore again on projects that otherwise would not have been economical. This situation will put pressure on revenues and results for many quarters to come.

Ensco CEO Carl Trowel said on the conference call:

we see positive signs for the offshore sector, including constructive commodity prices, attractive breakeven economics for offshore projects, and rig retirement. These factors have created a more favorable backdrop for the supply-and-demand dynamics for the offshore drilling rigs, and we believe the early stages of a recovery are taking hold.

Ensco - Balance sheet: The Raw Numbers

Ensco	1Q'15	2Q'15	3Q'15	4Q'15	1Q'16	2Q'16	3Q'16	4Q'16	1Q'17	2Q'17	3Q'17	4Q'17
Total Revenues in $ Million	1,164.0	1,059.0	1,012.0	828.3	814.0	909.6	548.2	504.6	471.1	457.5	460.2	454.20
Net Income in $ Million	324.7	260.3	292.0	−2,472.0	175.3	590.6	85.3	39.0	−25.7	−45.5	−25.4	−206.8
EBITDA $ Million	595.3	522.5	566.5	−2,351.0	427.4	795.9	247.3	217.2	167.9	142.8	151.7	10.6
Profit margin % (0 if loss)	27.9%	24.6%	28.9%	0	21.5%	64.9%	15.6%	7.7%	0	0	0	0
EPS diluted in $/share	1.38	1.11	1.24	−10.61	0.74	2.04	0.28	0.06	−0.09	0	−0.08	−0.59
Operating cash flow in $ Million	459.0	427.8	375.1	425.1	233.1	567.1	195.8	83.5	104.6	25.9	89.1	39.8
Capital Expenditures in $ Million	397.1	516.8	531.9	173.7	158.1	51.3	46.1	66.7	28.6	50.0	141.5	62.6
Free Cash Flow in $ Million	61.9	−89.0	−156.8	251.4	75.0	515.8	149.7	16.8	−178.0	−24.1	−52.4	−22.8
Cash and short term investments $ Billion	1.63	1.30	1.09	1.30	1.38	1.80	1.77	2.60	2.08	1.85	1.79	0.89
Total Long term Debt in $ Billion	6.13	5.93	5.90	5.87	5.86	4.91	4.70	5.27	4.94	4,75	4,75	5,10
Dividend per share in $	0.15	0.15	0.15	0.15	0.01	0.01	0.01	0.01	0.01	0,01	0,01	0,01
Shares outstanding (diluted) in Million	231.9	232.2	232.5	232.5	232.5	284.6	298.6	300.4	300.6	300.9	438.1	426.3

_{Note: Most of the data indicated above come from Morningstar and company filings.}

Trends, Charts, and Commentary: Revenues, Free Cash Flow, and Upstream Production

1 - Quarterly revenues

Total revenues declined to $454.2 million from $504.6 million in the year-ago quarter. However, we notice in the chart above that a revenue stabilization driven by a nascent recovery is shaping up as evidenced by the recent fleet status.

This period of stabilization is expected to take several quarters before we can eventually notice a slow revenue growth shaping up. Day rates are still an issue for the balance sheet and will put more pressure on margin in 2018. It is more noticeable with the jack-up segment than the floater segment right now because of the average contract duration.

Revenues for the floaters segment were $302.8 million in the fourth quarter, unchanged from $302.8 million a year ago. Revenues from the jackup segment decreased 26.8% to $136.5 million from $186.5 million a year ago.

The company expects now $1.72 to $1.8 billion in revenues for 2018. Based on $1.76 billion (midpoint), 2018 revenues will be 4.5% lower than the ones realized in 2017 ($1.843 billion). Total CapEx for 2018 will be approximately $475 million, significantly higher than in 2017.

2 - Free cash flow

1-Y Trailing free cash flow, FCF, is now negative $277.3 million, which is not a surprise in this market environment.

After looking at the graph above, I do not understand why Ensco is still keeping a dividend of $0.04 per share on a yearly basis, at the cost of $17 million. While it is not a significant expense, it is still an unnecessary expense that should be eliminated until the market recovers.

ESV is not passing the FCF test.

3- Quarterly backlog and commentary

Note: I believe the total backlog today is higher. The company announced that the Ensco 140 and Ensco 141 had been contracted long term, and I think the contract backlog should be above $3 billion.
The backlog is showing the same trend as the revenues with $2.8 billion. ESV has a robust jackup backlog representing over 38% of the total backlog.

Note: The company indicated that the Ensco 5005 would be retired.

4 - Net debt

ESV pro forma net debt is approximately $3.865 billion, including Atwood. It represents a net debt-to-capital ratio of 30.7%.

According to the company:

Financial Position - 31 December 2017

$2.8 billion of contracted revenue backlog, excluding bonus opportunities
$2.9 billion of liquidity
- $0.9 billion of cash and short-term investments
- $2.0 billion available under our revolving credit facility
$4.8 billion of long-term debt

Pro Forma Financial Position - 31 December 2017

On 10 January 2018, the Company issued $1.0 billion of new senior notes due 2026 and, more recently, repurchased $650 million aggregate principal amount of senior notes. Adjusting for these transactions, the Company's pro forma financial position as of 31 December 2017 reflected:

$2.8 billion of contracted revenue backlog, excluding bonus opportunities
$3.2 billion of liquidity
- $1.2 billion of cash and short-term investments
- $2.0 billion available under our revolving credit facility
No debt maturities until third quarter 2020 and only $308 million of debt maturing before 2024
$5.1 billion of long-term debt
$8.7 billion of Ensco shareholders' equity
31% net debt-to-capital ratio (net of $1.2 billion of cash and short-term investments)

ESV: Technical Analysis (Short term)

ESV is highly volatile, and the recent dramatic slide from $7.50 to now under $4.50 has been a surprise for many investors, including myself.

I warned last quarter that the offshore drilling industry was rallying for the wrong reasons and recommended to my followers to use these recent highs to take some profit off the table because while oil momentum was bullish, the offshore drilling industry was not showing any improvement.

However, the stock corrected quickly to re-test its lows in August 2017 (double bottom - buy flag). It is too early to see a pattern here, and I would use a range $4.20 (support) to $5.60 (resistance).

Commentary:

Ensco is a solid offshore driller caught in a stubborn bearish cycle that will remain active until the market sees a revenue improvement. The company is putting in place a firm defensive financial position while waiting for a recovery, by reducing costs and re-organizing its debt and liquidity to survive comfortably the last leg of this bear market where the jackup and the floaters market are improving. M. Carl Trowell said:

Moving to the broader market environment, we see positive signs for the offshore sector, including constructive commodity prices, attractive breakeven economics for offshore projects, and rig retirement. These factors have created a more favorable backdrop for the supply-and-demand dynamics for the offshore drilling rigs, and we believe the early stages of a recovery are taking hold.

However, M. Carl Trowell noted that:

While the longer-term demand prospects have improved for the floater market, the primary issue is that of rig supply. As a result, a more sustained recovery for this segment of the market is not expected until 2019, when we expect to see utilization improve before pricing power returns thereafter.

The recent acquisition of Atwood, which is now completed, still worries me because of the nature of Atwood fleet. Ensco acquired an IDLE modern fleet which is not creating any significant cash flow and looks like a gamble for a V recovery that I do not see at all. Perhaps a U recovery taking shape in 2019.

Cash flow is paramount when it comes to an acquisition in this industry. I cannot understand what M. Trowell was thinking and how a majority of shareholders voted for this unreasonable deal? ATW was heading for bankruptcy and waiting six months or a year would have significantly changed the situation and price paid.

Conversely, Transocean (RIG) acquired seven Semi Submersibles from Songa Offshore, with four of them (modern) contracted and three old Semi Submersibles cold stacked. The four semi-submersibles are contracted until 2022 to 2024 at a day rate of $444/d to $490k/d (with the five-year SPS scheduled in 2020-2021).

Transocean evidently acquired cash flow, over $3.8 billion in firm contract with Statoil (STO) with extended priced options that can add $3.1 billion to the initial backlog. Ensco, on the other side, acquired many idle floaters and five jackups (only one operating) with a backlog under $300 million. M. Trowell said:

Beginning with highlights from last year, we completed our acquisition of Atwood in October, adding 11 high-specification assets to our fleet at bottom-of-cycle prices. By purchasing Atwood, we took a critical step forward in enhancing the capabilities of our fleet and positioning Ensco to meet future customer demand.

If the recovery hopefully materializes in H2 2018 and 2019, then Ensco will not suffer long term from this ill-timed acquisition paid at a considerably higher value that I would have liked.

However, the deal is done, and we should cut Ensco some slack and let the company prove that it has made the right decision.

Important note: Do not forget to follow me on ESV and other offshore drillers. Thank you for your support.

This article was written by

Fun Trading

21.65K Followers

Fun Trading is a retired engineer and independent investor. In addition to writing on investing in all aspects of gold, oil, and gas, he runs his own portfolio..

Analyst’s Disclosure: I am/we are long ESV. 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 trade ESV actively

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Recommended For You

Let me preface my response by acknowledging your granular contribution to this site’s analysis of the drillers. I for one very much appreciate it and read your reports attentively.

As it regards my opinion on the fundamentals for this sector and my investment conclusion for the sector and ESV, I believe I have something to bring to the discussion.

As to my analytical grounding, for a decade I was a Wall Street analyst covering both the oil and the oil-service sectors. As it pertains to investing, in 1996 I left Wall Street and founded an investment-management firm which is now in its 21st year and possesses a performance record demonstrating both appreciation during the good times and risk management in the bad (thus the “Prudent Man” handle).

As it pertains to ESV specifically, at some future date this company within the sector would be favored by me but not as an “equity” investment. When the oil sector outlook catches a cold the service sector bears the consequences typically catching pneumonia. I believe the oil producers will remain exposed to the secular “downtrend” for oil prices that will continue to erode their leveraged cash flows leaving little of the pie to fund the driller’s recovery. In addition to the poor current outlook for the price of oil, which is at great risk due to the “backwardation” of the oil futures market, the long-term outlook for the price of oil will be constrained by weak global population growth (Africa is the only continent replacing its population at any meaningful rate), by political collaboration to substitute for fossil fuel, and by production technology that allows producers to virtually stick a straw in the ground and produce onshore profits. All of these trends will keep the offshore capital-equipment returns underwater (pardon the pun). Furthermore the offshore market has always reminded me of the tanker market with its cast of manufacturers that boom & bust, and corporate players that have little in common with their shareholders.

While it goes without saying that “an investor can profit from any investment and any industry” (though it appears you believe it had to be said), successful investment results must first be rooted in the quantification of investment-risk versus investment-return relative to one’s investment benchmark. In my humble opinion, again grounded in thirty years of experience with both this sector and portfolio management, a significant wave of restructurings must first occur (i.e. bankruptcies) to bring investment-reward in alignment with investment-risk. While ESV’s franchise would be a prized opportunity in the event a restructuring occurred, and one in which i would expect to partake, I believe the risk is that current ESV “equity” investors will be left with little to show for the risks they are taking by buying the stock today. Obviously, for the sake of current investors, I hope that the outlook improves and I am proven wrong.

Again, this is just one man’s opinion and I look forward to your ongoing coverage of the sector.