Why Is Ensco So Volatile?

Summary

• Ensco's stock price has declined substantially after running up substantially in late December and early January.
• This article explains one key reason why Ensco's stock price is so volatile.
• Investors should keep this in mind when placing their bets.

Yesterday in Offshore Drillers: Key Metric To Watch In 2018, I explained to Value Portfolio subscribers that I will be a keeping a close eye on certain metrics throughout the upcoming quarters, and also discussed why the stock price of Ensco (ESV) is so volatile compared to oil equities in general:

ESV data by YCharts

First, let's review two key measures of corporate valuations.

What Is Market Capitalization?

Ensco currently has 436 million shares outstanding, so at the last closing price of $4.42, Ensco's market capitalization, or the market value of its equity, was $1.93 billion. This figure represents the market value of Ensco's equity.

The following graph illustrates how Ensco's market capitalization has trended in the last three years:

ESV Market Cap data by YCharts

Market capitalization, however, does not tell the whole story.

What Is Enterprise Value?

Enterprise Value (not to be confused with Intrinsic Value) is a more comprehensive measure than market capitalization, and represents the market value of the business. The following graph illustrates how Ensco's enterprise value has trended in the last three years:

ESV Enterprise Value data by YCharts

Readers should note Ensco's enterprise is currently at $5.79 billion, or three times of its market capitalization. This is primarily because of the company's total debt balance of $4.76 billion, which will have to be paid regardless of what the company's stock price does. In other words, the total debt balance is relatively constant, and when the market capitalization changes, what really changing is Enterprise Value minus Debt.

Example

For illustration purposes, let's assume that, for whatever reason, the total price of the business (i.e. Enterprise Value) increases by 10 percent.

In this case, Ensco's enterprise value would increase from $5.79 billion to $6.37 billion. Since the debt balance of $4.76 billion remains relatively constant, the market capitalization of the company has now increased from $1.93 billion to $2.51 billion.

In other words, a 10 percent increase in the company's enterprise value (i.e. the market value of the business) has led to a 30 price increase in the company's market capitalization (i.e. the market value of the equity).

Bottom Line

Ensco's stock price, along with the stock prices of companies with high debt-to-market capitalization ratios, is extremely volatile.

This is why when oil prices fluctuate, which changes investors' estimates of the company's prospects and the estimated value of the business, Ensco's market capitalization (i.e. stock price times shares outstanding) fluctuates wildly, essentially swinging around the relatively constant total debt balance.

Investors should place their bets accordingly, which could mean limiting use of margin debt, diversifying holdings in offshore drillers, using hedging strategies as they deem necessary, and so on.

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.

Comments

[Augustinus 24]

Isn't the d/e level higher for the other drillers? Ensco being actually the lowest d/e major driller.

[22cents]

Reason? It’s what happens when you take on heavy financial leverage and operating leverage.

[Aventador]

The title of the article is Why Is Ensco So Volatile?

That is a question that is very easy to answer. Smart longs......very smart longs sell and lock in profit and buy the dips and sell the pops. Anyone who has paid attention the last few years in these OSD has seen and know its the only way to make some $$ . If today is your first day investing and you looked at the chart its obvious. This apply to ESV and across the OSD board.

[jacksalmon]

Can someone please explain why Enterprise Value adds the market cap plus the debt. It makes no sense to me why the value of anything would be calculated by adding the debt instead of subtracting it. If I have a net worth of $100,000 and take on a loan of $50,000, my net worth is $50,000, not $150,000. So, why isn't it the same for EV?

[ValueAnalyst]

Your "net worth" in your example is market cap.

Think of it this way:

Home value: $1m
Mortgage: $800k
Equity: $200k

Equity = market cap
Home value = enterprise value

We are trying to value the home, then subtract the mortgage to reach what your stake as the home owner is worth (i.e. market cap).

[Henrik Alex]

Come on. The article actually explains EV in detail (though I thought this would be basic knowledge for investors).

You need to look at EV from the perspective of a potential buyer:

Looking simply at the market cap might suggest that Ensco is pretty cheap given its asset base and contract backlog. But if you acquire the company, you are also acquiring Ensco's substantial debt so this needs to be added to the purchase price.

[rw1270]

The author explained how EV is calculated. To understand why, imagine EV as as a total "nominal" value of capital contributing (or committed) to the actual business ("enterprise"). This is why you also subtract cash from EV, as if it were theoretically returned back to the shareholders, "nothing" the actual business value should not change, except of course liquidity. However, if you took care of the liquidity issues, which for healthy businesses is usually taken care by revolving accounts, rest of the cash just sits there and does not contribute to the business. So EV = Market cap plus debt minus cash.

EV is not perfect measure, as it uses nominal debt value, not mark-to-market value (which may be too hard to get for an average investor). This would actually somewhat overestimate the value of the business, but should be good enough as a valuation tool for a healthy business. A little less helpful for a business in distress.

[Timothy Stabosz]

I’m not sure why it takes an article to explain to anyone the relationship between EV and the sensitivity of market cap to that, when debt is relatively high. Is this really the story of ESV’s excessive volatility, relative to other similarly levered players? I think it has more to do with an “unstable” and “transient shareholder base, which is, as much as anything, a consequence of the ATW merger, and additional ESV stock issuance, which resulted in more “hot money” in this name.

[Henrik Alex]

Correct. In addition, the acquisition of Atwood has increased the perceived risk level for Ensco.

[ALPHABUB]

Heavily owned by institutions-
When their motives change we smaller retail players are swept in the direction of new thinking by the big players. The argument on qtrly earnings can go both ways and misunderstood comments from the CEO have weak handed shares running.
Collectively the positive is the OSD space has bottomed, turned the corner, basing day rates surely will improve substantially with Oil at $70+ and above. We are heading in the near term to $65. Lots of positives and takeaways - ESV is undervalued and a excellent opportunity to acquire discounted shares below $5 with little risk in a improving market. World economies are all recovering demanding usage. Oil finds are apparent in Africa, Brazil, Mexico, Gulf etc
Deep water contracts are soon to flood forward with gushing returns
Way long here!

[johnny..cage]

Couldn’t be more obvious. Briol with the IEA thru every headline at the market today. None stuck and market laughed off his foolish buy side rhetoric. We’ll be back to 14 levels by mid summer. Then a nice big runway for shale to overproduce condensate while middle distillates remains in large demands.

[tech100]

Above $5 tomorrow..

[Fortunate One]

Lol. Yet another article pointing out unintentionally that the bonds are the better bet. Most on this post will disagree with me ...as they did at 8,7,6,5 and now a 4 handle on this stock. The bonds have sunk back to my cost. I tried to buy more today. Note the constant increase of shares outstanding....look at 5.75 Coupon maturing 2044 at $66.5. Probably money good in BK....8+ percent while you wait. Need to shoot from all the way across the court when an easy lay up is right there. Good luck to all.

[earlyriser]

While I disagree that today the debt is a better bet than the common, I do like your 2044 maturity. On ESV bonds, or for that matter, on any OSD debt. You want to go short like my 2021 bonds or very long like the 2044. ESV will either go bankrupt or not. Playing in the middle makes no sense. I actually may look at this maturity.

[Turbodan]

Where can I buy the bonds? I have some common stock but realize the bonds are the place to be for this company

[earlyriser]

VA, I have been playing in the OSD stocks for the last couple of years. Currently, I own ESV bonds and equity. The recent phenomenon that intrigues me is that while ESV bonds have been down, the stock has been slaughtered. The bonds are saying increased risk, but the stock is saying a high potential for bankruptcy. I would have tendered my 2021 bonds yeilding roughly 5%, but since ESV has termed out their debt, they are totally safe. I am at about my maximum position in ESV, last purchased at $4.48.

[ValueAnalyst]

Thanks for your comment. Nice to see you again.

I wouldn’t interpret the latest move as potential for bankruptcy, but usual volatility in a heavily shorted company with a highly levered balance sheet. If you check the shortvolume.com website for ESV, you’ll see that the stock is being heavily manipulated by shorts.

I’m perfectly fine sitting on my hands for as long as it takes. Shorts are the ones who need to worry about time.

[Weathering]

Can I ask what “termed out their debt” means? I’m a bond investor but self-taught so I don’t know all the vocabulary. I tendered all my ESV bonds and some RIG as well as 2019s in NE. Now I only have RIG (2027s) and NE (2024&2025). May look to re-but ESV bonds.

[earlyriser]

I am mostly a stock guy, but have spent the last decade looking at both. ESV, termed out their debt, meaning that they rolled close in debt to later maturities. Therefore, my 2021 will mature much earlier than most of their debt. So I feel very protected vs the possibility of bankruptcy.

[Henrik Alex]

Didn't you predict a major short squeeze in the shares just recently:

https://seekingalpha.c...
https://seekingalpha.c...

And what about that significant accumulation?

https://seekingalpha.c...

[ValueAnalyst]

Thanks for your comment. I’m in ESV/NE/RIG as well as TSLA for the longer term, so whether or not a short squeeze happens in any of those stocks is not relevant to my investment theses. A short squeeze may still happen as short interest remains high, and ownership concentration has increased.

Did you have something to say specifically about this article? I expect higher quality and relevant input from fellow contributors.

[johnny..cage]

As in other comments Henrik predicts shale will fill the deficit similarly as the IEA does today. This is backwards thinking as the bulk of demand today is largely found in diesel/jet fuel and IEA has yet to explain how one can magically turn shale condensate into larger middle distillates molecules. Drilling not done today will have to be done tomorrow. The growth in US crude in the last six months has been largely over 45API. Won’t be long before we start calling shale oil Black (Fools)Gold.

So ya cut on ESV making an offensive move at the bottom to surround itself with assets necessary to obtain what the market actually needs. Assets that will drill up new waters in Brazil, Guyana, Mexico. There’s what 75-100mb globally to go thru until we’re back at 14 levels? We are already showing a Q1 deficit and VLCC’s are loading up with GOM crude while standing inventories grow lighter each day.

[Coffeestain_Investor]

Actually, with reforming and Fischer-Tropsch synthesis you can produce literally any kind of hydrocarbons (in this case for example diesel/kerosene) from any kind of carbon source. There is no magic to it. Only a tremendous amount of capital investment and energy required to do so (and process selectivity and efficiency being non-trivial issues).

While that is true, i do not suggest it will economically viable or let alone competitive. And yes, i don't appreciate IEA, EIA summing all those light API liquids as crude oil.