Others Are Fearful About Ensco Plc: You Should Be Greedy

Shares of offshore drilling contractor Ensco have taken a significant beating lately due to the turmoil in the offshore drilling industry. However, Ensco itself is unlikely to be affected by this turmoil. This may present an opportunity for a savvy investor to buy shares of this very high-yielding stock at a cheap price.

Apr 2, 2014 at 8:47AM

Shares of Ensco plc (NYSE:ESV) have taken a beating over the past few months as the market aggressively sells off shares of offshore drilling contractors due to the weakness in the overall sector. Basically, constrained cash flows at many exploration and production companies have resulted in a slowdown in contracting activity while these companies reexamine their budgets. For this reason, the drilling market has gone from one in which demand for drilling rigs greatly exceeded the supply of offshore drilling rigs to one in which supply and demand are much more equally matched. The Ensco sell-off might be a case of throwing the baby out with the bathwater. Indeed, Ensco's stock looks quite appealing at these levels due to the company's very low debt load, low rig availability, and high dividend.

Low debt load
One reason why Ensco is much safer than the market has given it credit for is because the company has one of the lowest debt loads in the industry. A company with a high debt load can be risky because the company carrying the debt can quickly run into financial trouble if its cash flows decline. The opposite is also true. A company with a low debt load has a much wider range of options should its cash flows decline. Here is how Ensco's leverage compares with that of several of its largest peers:

Screen Shot

Source: ISI Group Oil Services Data & Valuation Handbook 28 February 2014 via Ensco

As the chart shows, Ensco is much less likely than a company such as Seadrill (NYSE:SDRL) to encounter financial problems should the weakness in the industry cause the cash flows of the various drilling companies to decline.

Secure cash flows
In Ensco's case, it is unlikely that cash flow will decline due to the weakness in the industry. This is because of the way that the industry works. Unlike many other companies, offshore drilling contractors are not dependent on day-to-day sales. Instead, the companies contract out their rigs to exploration and production companies for extended periods of time lasting for several months to several years. The revenue that the company will generate during the term of the contract is fixed. Although this revenue can vary slightly due to downtime and other factors, it truly is about as close as we can get to guaranteed revenue.

This business model is the reason why it is unlikely that the weakness in the industry will have a negative impact on Ensco's cash flows. This is because the company has secured contracts for nearly all of its rigs lasting for most of the year. In fact, about 90% of Ensco's revenue outlook for 2014 is secured by contracts that are already in place. This means that Ensco is effectively guaranteed to receive approximately 90% of its revenue guidance of $5.273 billion . This fact offers investors a significant amount of safety.

New rigs to drive growth
Ensco currently has seven offshore drilling rigs under construction, which will leave the shipyard to join the company's fleet over the next two and a half years. Three of these rigs are ultra-deepwater drillships and the remaining four are shallow-water jack-ups.

Screen Shot

Source: Ensco

These seven rigs will be the drivers of Ensco's growth going forward as each leaves the shipyard and begins operating for whichever of the company's customers contracts out the rig. As the chart above shows, three of these new rigs will be delivered this year. However, Ensco has only secured contracts for two of them. If Ensco is unable to secure a contract for the third uncontracted rig then the company will be forced to idle the rig and will not earn any money from it but will still incur some costs for holding the rig idle. While Ensco is still likely to see forward growth, the risk that the company may have to idle the rig is one that investors should be aware of.

High dividend yield
The recent decline in Ensco's share price has pushed up the company's formerly moderate dividend yield to a high level. Ensco currently pays a dividend of $3.00 per share. This gives the stock a 5.68% yield at the current price. This high yield thus makes the company an appealing investment for both income and value investors.

Daniel Gibbs has a long position in Seadrill. His research firm, Powerhedge LLC, has a business relationship with a registered investment advisor whose clients may hold shares in any of the stocks mentioned. Powerhedge LLC has no position in any stocks mentioned and is not a registered investment advisor. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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