After posting surprisingly upbeat earnings in the second quarter that involved some big one-time benefits, Ensco's (VAL) third-quarter results weren't nearly as chipper this time around. Continued weakness in the offshore market led to more rigs coming off contract, and with it, the company's profits. While the numbers suggest things are going to get tough for Ensco in the coming quarters, its management seems a bit more upbeat.
Here's a quick look at the results this quarter and why the company sees better times around the bend.
Image source: Ensco investor presentation.
By the numbers
| Results* | Q3 2016 | Q2 2016 | Q3 2015 |
|---|---|---|---|
| Revenue | $548.2 | $909.6 | $1,012.2 |
| Operational income | $115.4 | $419.6 | $402.7 |
| Net income | $85.3 | $590.6 | $292.0 |
| Earnings per share | $0.28 | $2.04 | $1.24 |
*in millions, except per-share data Data source: Ensco earnings release.
That rapid decline in earnings from the prior quarter can be very alarming, but much of that has to do with some large one-time gains that the company took in the prior quarter that boosted earnings. If we were to strip out those gains, net income for the second quarter of 2016 were closer to $145 million. That makes this past quarter's $85 million in net income look not quite as bad.
The big drop in earnings came mostly from its higher-margin floating rig business, where in the quarter two rigs went off contract and a third received an early termination notice. It also doesn't help that Ensco renegotiated dayrates with some producers at significantly lower contract rates. Granted, this was something that the company needed to do to keep these rigs working, but it has had a pretty significant impact on earnings.
Data source: Ensco earnings releases. Chart by author.
The one thing that you can say the company did well this quarter is that it controlled its costs rather well and minimized downtime for its contracted rigs. Operational utilization -- the utilization rate of rigs under contract -- was 99%, and Ensco was also able to reduce drilling contract expenses by 31% compared to this time last year by lowering headcount and cold stacking or scrapping some older rigs rather than swallowing the costs of keeping them available for contracts.
We should also give it credit for cutting debt levels down quickly this year while it still has some cash coming in the door. So far in 2016, management has lowered its long-term debt from $5.9 billion to $4.7 billion today.
What management had to say
With results like this past quarter, there isn't much management can do other than reassure investors that the company will get trough this. CEO Carl Trowell's statement for the quarter pretty much went along those lines, but he also hinted at better times ahead:
In terms of our fleet management strategy, as noted in our most recent Fleet Status Report, we've decided to preservation stack additional rigs to reduce costs in light of excess marketed supply within our fleet. Please note, however, we continue to maintain ready-to-work rigs by region and rig type for new contracting opportunities. We believe this portfolio management approach balances marketing available rigs with expense management as we navigate the downturn. Another aspect of our fleet management strategy is removing older, less capable rigs from our the fleet. We recently moved 2 rigs, ENSCO 53 and 94, to held for sale, as noted in our most recent Fleet Status Report, since we expect to sell them in the near term for scrap value. As we've stated previously, rig scrapping will be an important factor in helping to rebalance rig supply. We believe there is more scrapping to come in our sector.
On the demand side, improving breakeven economics will help to increase customer demand for offshore drilling rigs. We've seen several recent announcements by major customers and suppliers across the offshore supply chain showing that breakeven economics for offshore projects have improved significantly through reengineering and improved project management. This is a critical step in terms of increasing the overall competitiveness of offshore programs and laying the groundwork for future improvement in market conditions once customers free up more capital spending for their offshore projects. We have also seen positive indications that certain key offshore markets, like Brazil, may lessen restrictions that allow greater participation and investment by more E&P customers...
This statement about more and more rigs getting scrapped may paint the market in slightly rosy terms. Sure, oil prices are starting to stabilize, places like Brazil are liberalizing their oil industry restrictions, and some new discoveries are getting some producers excited to start work. The thing to remember, though, is that Ensco and its peers have a lot of idle rigs, and that will significantly lower contract rates. Also, there is no guarantee that Ensco will win those contracts.
What a Fool believes
Ensco is clearly still in capital preservation mode as there isn't a whole lot of work for its idle fleet, and there won't likely be much work for it in the coming quarters. Looking at the company's financials, Ensco seems to have plenty of cash to get through the rest of this tough patch, but earnings are going to struggle as more rigs are more likely to come off contract than earn new work. There are some very early signs that things will get better, but investors shouldn't expect a quick turnaround.
