Does Ensco Deserve Its Low Valuation?

The world's second largest offshore oil and gas drilling company, Ensco  (NYSE: ESV  )  has had a poor year. Well the company hasn't, but the stock has; down 5.5% year to date, despite analysts expecting the company to report earnings per share of $6.5 for the full year, up 25% compared to last year.

What's more, the company trades at a significant discount to sector peer and world's largest offshore driller by market capitalization, Seadrill  (NYSE: SDRL  ) . On a forward price-to-earnings multiple of 7.5 and price-to-sales ratio of 2.8, Ensco's valuation is lower than that of Seadrill, which trades at ratios of 12.2 and 4.4 respectively. Having said that, Seadrill does offer an 8% dividend yield, which I discuss in detail here.

More than just the valuation
However, I believe the key to Ensco's low valuation lies in the company's fleet and outlook rather than its historic growth and strength. First, the fleet: 60% of Ensco's is jack-up rigs, the rest of the fleet is composed of drill ships and semisubmersible rigs ( floaters). In fact, Ensco's floater fleet is the newest floater fleet in the business, well placed to capitalize on the rising demand for new, high-spec drilling systems.

Having said all of that, analysts at Goldman Sachs expect that the day rates for the global jack-up rig fleet are set to decline over the next few years as, due to orders already placed with shipyards, the global jack-up fleet is expected to expand 15% by the end of 2014 . It is likely that Ensco could note a fall in revenue do to this oversupply.

In comparison, Seadrill's fleet is equally weighted (including rigs under construction) between jack-ups (50% of fleet) and floaters (50% of fleet) so, the company is unlikely to note as much of a depression in revenue from the decline in jack-up rates .

However, in comparison to Ensco, Seadrill is investing heavily for future growth. Currently, according to Seadrill's 28th August fleet status report, the company had 12 floaters under construction and 10 jack-ups, which is set increase the company's fleet by around 50% during the next few years. Ensco's in comparison only has four new drill ships and four jack-ups on order; an 11% increase to its current fleet. Investors examining this point will need to rely on their expectations for the offshore markets future. If the market becomes over-saturated, Seadrill's expansion plans could place its debt level and dividend in a precarious position. 

Backlogs
Furthermore, cracks start to show when examining Ensco's backlog and current fleet commitments. Ensco has an order backlog of $11 billion, locking in two-and-a-half years of revenue; based on the company first half revenue figure of $2.3 billion. In addition, Ensco's fleet is currently assigned to many independent oil & gas producers, which to some extent exposes the company to both credit and liquidity risk .

On the other hand, Seadrill's current backlog is worth 25 quarters of revenue, based on Q2 figures. In my opinion, Seadrill's larger order backlog, coupled with its large fleet expansion coming online during the next few years justify the company's valuation premium when compared to Ensco. Additionally, Seadrill's customers are mostly large multi-nationals so there is less customer credit and liquidity risk than Ensco is exposed to .

Fracking revolution
Meanwhile, an alternative to the off-shore drillers would be Noble Energy  (NYSE: NBL  ) , which is highly active in the fracking and specialist oil and gas extraction industries. This is key for the future as companies and countries seek to unlock inaccessible hydrocarbon reserves through fracking, a method that was previously too expensive but is now worth the reward thanks to new technologies.

Fracking and the experience that Noble has in the industry could be key for Mexico, which has huge sales deposits but not the experience to extract them. Mexico's state monopoly Pemex runs the oil and gas sector accounting for one third of Mexico's revenue but production is declining, hitting 2.94 million barrels per day during 2011 from 3.59 million during 2002. Noble's fracking experience could be invaluable in unlocking Mexico's reserves, yet another huge opportunity for the company. More information on Noble and Mexico's oil boom here.

Foolish summary
All in all, despite being the world's second largest drilling company, Ensco's growth and backlog is lagging behind that of its peers. In addition, while the company flounders and loses investor support, its competitor, Seadrill is surging ahead and the fracking revolution has resulted in boom in profits for the onshore drillers.

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  • Report this Comment On September 19, 2013, at 1:07 PM, Hueyones wrote:

    You might get a higher stock price return from here with Seadrill than Ensco, but Seadrill is a far riskier stock imo. SDRL has the highest leverage ratio among the major drillers and their dividend payout ratio is 120% of 2013 estimated earnings, which puts the dividend at risk. Moreover, Seadrill has had two huge earnings misses just within the last year where Ensco has had none. Ensco's leverage ratio is only 39% of Seadrill's and Ensco's conservative payout ratio is a quarter of Seadrill's with plenty of room to be increased. Ensco also has enjoyed the highest net income margin in the industry over the last eight quarters at 27%.

    Ensco's lower length backlog is by choice. They have three ultra deepwater rigs under contruction and three jackups under construction which they are funding internally and not currently marketing yet. Two of the jackups are ultra premium jackups which include proprietary technology that ESV has patented. ESV expects to get higher contract rates for all these rigs by marketing them later rather than today.

    And looking at Ensco's fleet status report, I see at least 80% of their fleet is contracted to very well known, high quality names like Saudi Aramco, Petrobras, Pemex, BP, Maersk, Anadarko and Apache.

    Imho, buying ENSCO stock here gives a person a relatively low risk shot at 25% upside within a year.

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