Offshore contracting giant Ensco plc (VAL) announced its first quarter 2014 results on Monday, April 28. These results were slightly worse than last year's, but overall they weren't too bad, and there are some trends in there that are likely to prove very good for the company over the coming quarters. One thing that these results show quite clearly is that Ensco is not as affected by the much-publicized weakness in the offshore drilling industry as some of its peers. However, the company's stock price has reacted as though Ensco is highly exposed to this weakness. This creates a buying opportunity for savvy investors.
One thing that I like to do when discussing a company's earnings results is to share the highlights from the report, as that helps to frame the ensuing discussion.
Highlights from the earnings report
In the first quarter of 2014, Ensco reported total revenues of $1.187 billion. This is a 3% increase from the first quarter of 2013 in which the company had $1.150 billion in revenue. Unfortunately, this increase in revenue did not translate into higher net income and, in fact, Ensco's net income fell compared to the prior year quarter. In the first quarter of this year, Ensco had net income of $296.7 million. This compares to $319.9 million in the first quarter of last year.
Reasons for the decline
There were two major reasons for the year-over-year decline in Ensco's earnings compared to the prior year quarter. The first is that Ensco's costs increased due to the need to perform maintenance on several of its rigs. An offshore drilling rig is just like any other piece of machinery in that it requires regular maintenance and inspections in order to operate at optimum levels. And, it costs Ensco money to perform this work, just like it costs you money when you take your car in for service. So, the increased maintenance work is one reason why the company's net income went down.
The second reason for the decline is that Ensco had less rigs working in this latest quarter than it did in the first quarter of last year. Basically, the company had some of its rigs come off contract during the quarter. This is because the company's customers only need to use a rig for a certain period of time and so they only put it under contract for that time frame. When that period of time ends, the rig is said to come off contract, the customer stops using the rig, and Ensco stops getting paid for it. So, the fact that some of the company's rigs came off contract also had a negative impact on the company's profits because Ensco has to pay to either move the rig to a shipyard for maintenance or move it to a new location to start work on its next contract.
Higher dayrates
Ensco noted one thing in its report that Diamond Offshore (DO) also noted in its first quarter report. This is the reason why the company's revenues went up even though it had fewer rigs working. That is that the company's average fleetwide dayrate went up. This does not directly contradict Wall Street's statements that dayrates are going down industrywide because the rigs that went off contract were presumably ones with lower than average dayrates and Ensco saw some of its new rigs with higher dayrates start operating during this quarter. This would have the effect of pushing the company's fleetwide average dayrate up.
However, it does give us reason to be somewhat skeptical of analysts' downgrades, particularly since not all companies in the industry are affected equally and, in Ensco's case, revenues also went up. At least in the shallow-water subsegment, recent contract announcements by Seadrill (SDRL) show that dayrates are actually increasing for the most modern and sophisticated jack-ups.
Ensco well positioned to ride out the turbulence
Ensco is one offshore drilling contractor that is well positioned to ride out the turbulence in the industry given the company's low near-term availability and strong contract status for this year. In its fourth quarter 2013 report, Ensco stated that 90% of its 2014 revenue outlook is secured by contracts that are already in place. This means that Ensco is guaranteed to generate at least 90% of its revenue outlook for this year and that is a very good place to be.
Reasonable valuation, high dividend yield
As I stated earlier, Ensco's stock has been beaten down even though the company is not as exposed to the weakness in the offshore drilling industry as peers such as Diamond Offshore.
This has created a buying opportunity for savvy investors. Due to the sell-off, Ensco now trades at a price/earnings ratio of 8.27. The stock's dividend yield has also increased dramatically to 6.00%. Thus, the unfounded fear surrounding the company has created an opportunity for investors to get paid very well while waiting for the industry to recover.
