When companies report earnings they also usually give investors a chance to talk to management about how the business is going. For offshore drillers like Ensco (VAL) it's a chance to tell us how falling oil prices are affecting business and what we should expect for the rest of this year and into 2015.
Ensco's CEO Carl Trowell and his team certainly gave investors a lot to think about after the third quarter conference call. Here are the top five things investors should know.
2015 could be rough, especially for old rigs
"Since our last earnings call, oil prices have declined markedly. Customers are currently in the process of setting 2015 budgets. We will not know whether planned activity will be cut until the end of the fourth quarter. We expect that 2015 will be challenging in terms of utilization and dayrates, especially for older floaters coming off contract. And there is uncertainty around 2016 activity." --Carl Trowell, CEO
The fear for investors right now is that low oil prices will result in a huge decline in demand for offshore drilling rigs. In some markets that may be the case, notably older floater rigs.
One of the reasons floaters will be hit hardest is because there's a massive bifurcation in the market between rigs that are 30 years old or more and five years old and younger. The younger rigs are having no trouble finding work but the older rigs will struggle this year and beyond.
"The issue in the jackup market is new rig supply, not a lack of demand. ... The impact of new supply will not be instantaneous and much of it is coming from speculators or new entrant companies. Since our last call, we have contracted five Ensco jackups for multi-year terms, four of which are more than 30 years old... customers are not focused solely on new [rigs]. They want complete drilling solutions from dependable contractor drillers with proven operating systems." --Carl Trowell, CEO
The jackup market, which can be very volatile, has been robust for Ensco and others in the industry. And while new build rigs entering the market are a challenge, many are coming from speculators and not experienced drillers. So, Ensco should continue to win its fair share of new contracts.
Short term, this is good news because jackups are helping drive profit growth in 2014, and if they remain strong next year they could pick up some slack in the floater market.
"We do, however, continue to see challenges for the floater market, including some rigs going idle recently in certain regions. New rigs coming into those markets compounded by a decline in tenders and inquiries, have created a supply and demand imbalance." --David Hensel, SVP of marketing
The biggest risk to Ensco is its aging floater fleet, which is being replaced by newer rigs but is still vulnerable in the mean time. There are currently five semisubmersibles held for sale, meaning management is trying to get rid of them rather than invest in them for the future. The ultimate downside would be if management has to scrap these rigs because it can't find new contracts or sell them.
Keep an eye on what management does with these rigs and the rest of the older fleet in the coming months. If older rigs can't find contracts it could be a huge drag on results going forward.
Time to kill
"We could talk forever today on the market implications of the drop in crude, which is the big change since we last reported. I think what's fair to say, and important to say, is that as of yet during the quarter in Q3 we have not seen any response or material movement from our clients to the oil price moves. But neither would we expect to because it's not just an instant reaction." --Carl Trowell, CEO
Something that's often lost in daily trading of oil and stocks is that the oil business actually has a very long time horizon. Companies think in decades when making capital decisions, and a 25% drop in the price of oil short term is just part of the game.
We shouldn't be surprised that multi-year contracts also haven't come to a screeching halt because oil prices fell during the last three months. From that perspective, we should take a much longer view of the energy industry than react to what oil prices are doing today.
All about the dividend
"Today, we have a very strong financial position including $11 billion in contracted revenue backlog, which provides us with significant visibility into future cash flows. We have the lowest leverage ratio of our major competitors at just 33%, we have more than $1.4 billion of cash and short-term investments and $2.25 billion of fully available revolving credit facilities. This strong financial position supports our dividend commitment of $3 per share annually." --Jay Swent, CFO
If there's one thing that offshore drilling investors are worried about it's a big cut in dividends. Ensco's dividend yield is 7.3%, and that's not even close to the 18.4% yield of Seadrill's shares, which indicates that the market doesn't believe the dividend will last.
But Ensco's management has worked hard to maintain financial flexibility and maintain enough cash to pay for $2.4 billion of projected capital expenditures through the end of 2015. For now, that should help investors sleep at night.
