Why I Wouldn't Buy This Offshore Driller Right Now

Offshore rig lessors are down across the board in 2014. In a few ways, offshore drilling and deepwater drilling are the "frontier" of oil activity in the world. Deepwater and ultra-deepwater, which refer to depths of 5,000+ and 7,500+ feet respectively, are some of the most capital-intensive drilling operations that are accessible to international capital.

That is precisely why the offshore rig lessors are down so much. If oil prices fall, deepwater operations will not be as insulated as the better shale or CO2-injection oil plays are. Furthermore, if the lessors build too many rigs, oversupply could significantly reduce day rates and therefore hurt profitability.

At this time, investors are more concerned about the latter. There is now little doubt that dayrates are softening, and nobody seems to know how long this soft period will last. One lessor with significant offshore exposure to dayrate downside is Ensco PLC (NYSE: ESV  ) . As an operator, Ensco is actually one of the best players in this space. Unfortunately, because Ensco has a relatively high number of ships that are uncontracted right now, the company is also one of the most exposed to day rate declines. 

Ensco Investor Relations

Here we see that Ensco has relatively few of its scheduled new build ships contracted. To be fair, management expects an agreement to be reached on the DS-8 drillship sometime soon. However, the other half of all newbuilds are still uncontracted. An additional four deepwater or ultra-deepwater drillships will roll off of their contracts this year. This represents a large portion of Ensco's floater fleet. Most concerning of all, total fleet utilization declined from 86% to 78% in the most recent quarter. 

Still a blue-chip operator
In previous articles, I've mentioned that Ensco's relatively low leverage ratio (the lowest in its peer group), high net income margin (thanks to fleet standardization), and low dividend payout ratio (a mere 49% of earnings per share) made the company a lower risk blue-chip choice among the offshore lessors. This is still true. Dividend investors in particular can continue to rest assured that the company's dividend will be safe. We may be entering a challenging rig market, but things would have to get much, much worse before Ensco's dividend comes into jeopardy.

Bottom line? There are better choices right now
Over the last month, it has gotten harder to deny the challenging market situation the offshore lessors face. Therefore, the better choices will be those lessors that have higher utilization rates and those that have more successfully contracted out their fleets. Consider Seadrill (NYSE: SDRL  ) , which continues to have a total utilization rate in the high 90s. Unlike Ensco, Seadrill also has a majority of its scheduled newbuilds already contracted. At the end of the day, Ensco's dividend will be fine, but there are better choices out there right now.

Another low-risk play on offshore drilling
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