Ensco PLC is Taking the Necessary Steps to Ensure Future Growth

Ensco's upgrading of its fleet may stoke fears of future costs, but the long-term fundamentals of deep-water oil drilling remain sound.

Feb 27, 2014 at 1:04PM

Oil driller Ensco PLC (NYSE:ESV) is in a difficult spot. It has an aging jack-up fleet that needs to be addressed and an industry with near-term question marks. The company is growing, but the future is cloudy because upgrading its fleet is going to be a fairly cost-intensive effort.

It's worth noting that this isn't an Ensco-specific issue. There's a fair amount of doubt cast across the oil drilling space, for the very same reason. Many oil drillers face the prospect of higher costs to upgrade their fleets. For example, Diamond Offshore (NYSE:DO) plans to more than double capital expenditures this year. Its spending on newbuilds, upgrades, and maintenance of its fleet is expected to total $2.1 billion in 2014, compared to $1 billion in 2013.

At the same time, Ensco enjoys undeniable tailwinds, thanks to strong underlying demand for its floaters and jackups. The global thirst for energy seems to be insatiable, as emerging markets keep devouring oil at a startling pace. In addition, a greater percentage of oil is being discovered in extremely deep waters, where Ensco thrives.

Put it all together, and although the market perceives Ensco's long-term state to be a mixed bag, the company has a very profitable future in store.

Ensco's highly profitable year in review
Ensco's 2013 results were very solid across the board, and yet, the market seemed thoroughly unimpressed. Revenue and diluted earnings per share last year rose 14% and 20%, respectively, versus 2012. Strong performance was spread evenly across Ensco's two major operating segments, floaters and jackups.

Floaters revenue grew by 16% and jackups revenue increased by 17%. The primary driver of such strong revenue performance was increasing day rates for Ensco's fleet, which reflects the strong underlying demand for its rigs. Members of Big Oil desperately need rigs to produce oil, and are willing to pay more for them.

Ensco's results compare relatively in-line with most competitors. Seadrill (NYSE:SDRL) saw its contract revenue rise 14% in 2013, driven by both new rigs coming on-line as well as an increase in day rates. In the fourth quarter, Seadrill brought its West Tellus, West Auriga, West Vela, West Tucana and AOD III into service. Likewise, Ensco added three rigs to its active fleet in the most recent quarter, which will help oil drillers boost results in the months ahead.

Fleet restructuring under way
Ensco acknowledges it's got some aging rigs in its fleet, and isn't hiding it. Management deserves credit for tackling the issue head on. For example, earlier this month Ensco sold two jackup rigs for $33 million. Both rigs were built in 1979 and obviously past their prime. Over the past four years, Ensco has sold 13 rigs and reinvested the proceeds back into its fleet. The moves were part of Ensco's broader management initiative termed the 'high-grading strategy'.

Ensco's plan is to sell off older, under-performing rigs and reinvest the proceeds in newer designs. While this may cause some churn in the company's cost structure, it's a necessary evil nonetheless. Ensco has six rigs under construction, three ultra-deep water drillships and three premium jackups. These will presumably come at a considerable cost, so it's imperative to raise as much funds from possible from older rigs while they can still be sold at a profit.

Bet on deep-water oil drillers
On the surface, oil drillers face an uncertain future. Headline risk has reared its ugly head again, now that economic slowdown in the emerging markets is threatening one of Ensco's best geographic opportunities. Plus, the fleet upgrading currently under way has scared investors that future profits will disappoint due to rising costs.

However, short-term worries only hide the long-term potential of deep-water oil drilling, which remains strong. Key fundamental drivers for oil drillers like Ensco, such as day rates and utilization, are sound. This is indicative of the fact that oil drilling simply isn't going anywhere any time soon, thanks to booming global energy demand.

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Bob Ciura owns shares of Ensco. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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