Ensco PLC: The Low(er)-Risk Offshore Investment

Many retail investors seem put off by offshore drilling, and it's not hard to see why. Offshore rig lessors are in a capital-intensive business: It takes a lot of capital to build the modern drillships in operation today, and therefore many lessors are heavily indebted. In addition, the business of leasing these rigs is a very cyclical one: Rig dayrates can vary sharply based on oil prices and demand for offshore rig activity. And because many offshore lessors pay much of their income to shareholders in the form of dividends, spikes and troughs in dayrates can and have disrupted dividend payments. 

Source: Ensco investor relations.

But as we can see in the chart above, offshore production is a pretty solid secular growth story. As older, traditional onshore oil fields mature and their production declines, it will be up to new offshore oil sources to take the place of the older fields and satisfy the needs of a world still demanding more energy each year. For the scaredy-cats who want exposure to this sector, Ensco (NYSE: ESV  ) is the clear choice. 

Low leverage, simple debt structure

Source: Ensco investor relations.

First and foremost on the minds of risk-averse retail investors is debt. As we can see here, Ensco is the least levered of its peer group by a good margin. Ensco's very manageable total debt of $4.7 billion is just 2.5 times operating cash flow, once again among the lowest of its peer group.

But it gets better than that. A few offshore lessors have some pretty complicated balance sheets, with not only bonds but also credit "facilities" associated with individual rigs. Think of these credit facilities as basically "mortgages" on the ships. These mortgages are adjustable ones linked usually to LIBOR, and companies that hold these facilities must buy rate swaps in order to "fix" the interest rates of these facilities. But an investor in Ensco won't have to worry about these facilities, as Ensco's debt is only in normal bonds, and all of these are fixed.

Low dividend payout ratio

Source: Ensco investor relations.

Those who want an ironclad dividend in offshore lessors should look no further than Ensco. As of 2013, Ensco paid less than half of its earnings per share in dividends. This means that earnings could be cut in half before the dividend would be put in any danger, which is a claim that neither Seadrill (NYSE: SDRL  ) , Diamond, nor Transocean can make. In fact, both Diamond and Transocean have had to cut dividends in the past due to the volatile and cyclical nature of the offshore business. Ensco's 5.8% dividend is just about the closest thing to a guarantee in this industry. 

... and a pretty young fleet
Since the Macondo disaster in 2010, offshore producers have put a premium on leasing newer, safer, and more well-adapted rigs. So, not only is the demand for rigs growing (due to increased offshore energy activity), but demand is also concentrated in the newer ships. Ensco is one of the handful of lessors able to quickly adapt to this new reality. 

Source: Ensco investor relations.

Of the big players, Ensco's fleet is indeed pretty young, although Seadrill edges Ensco out.  Although Ensco isn't the very best in this category, it is still in that upper tier. Compare this with Diamond and Transocean, whose fleets are quite aged, and we can see that Ensco has anticipated well the needs of its clients. 

Bottom line
In my opinion, investors have a couple of good choices when it comes to offshore drillers. Smaller operators like Atwood Oceanics (NYSE: ATW  ) provide steeper growth prospects. Of the larger players, Seadrill's fleet is the youngest of all the majors. Both names are great, but I think Ensco provides a viable low-risk, large-cap alternative to highly leveraged lessors. With a secure dividend yield of 5.8%, the risk-averse, income-oriented, long-term investor should consider Ensco. The company's motto is "exceeding expectations," and I don't think it will disappoint.

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