The last time that Ensco (NYSE:ESV) was able to post an increase in revenue that didn't involve a customer paying an early termination fee for a contract was all the way back in 2015. This past quarter, though, the company finally made that crucial pivot back to revenue growth with newly awarded contracts for its rigs. For shareholders that have suffered through this long decline, this is great news.
Before getting too excited, though, investors should keep in mind that a return to revenue growth may not necessarily be immediately followed by a return to profitability. Let's take a look at the company's most recent earnings result and discuss what it will take before Ensco can get back to turning a net profit.
By the numbers
|Metric||Q2 2018||Q1 2018||Q2 2017|
|Revenue||$458 million||$417 million||$457 million|
|Operating income||($32.6 million)||($51.3 million)||$27.8 million|
|Net income||($151 million)||($140.1 million)||($45.5 million)|
Ensco was able to join some of its peers in posting its first revenue increase since oil prices started to crash in 2014. The driver of that higher revenue result was its newest rig, Ensco DS-10, starting operations in the first quarter under contract with Royal Dutch Shell. There was some additional revenue from its acquisition of Atwood Oceanics, but on a combined basis this rig was the difference maker for overall revenue.
Unfortunately, though, operating costs continue to increase faster than revenue. Part of that is by design, as management is putting money into its idle rigs in order to get them ready to be marketed to customers. Even though Ensco has several rigs coming off contract in the next two years, management thinks that drilling activity will pick up enough that these additional rigs will be needed.
What management had to say
In Ensco's press release, CEO Carl Trowell highlighted the fact that it had completed the integration process for its Atwood Oceanics acquisition and touted the benefits Atwood's fleet will have on Ensco in the long run:
We have now substantially completed integration activities for the Atwood acquisition and finalized synergies totaling $85 million on an annual run rate basis beginning in 2019. The Atwood acquisition added several modern, high-specification assets to our rig fleet and helps to better position Ensco to meet higher levels of customer demand for the most technically capable rigs in both shallow- and deep-water.
Trowell also gave a broad overview of the company's outlook and the current state of the offshore market:
While we continue to expect a protracted recovery and competitive near-term market conditions for the offshore drilling sector, sustained higher commodity prices are helping customers generate excess cash that can be deployed toward investments in future production. Along with lower offshore project costs, this has led to an increasing number of tenders and inquiries from customers that we expect will provide a pipeline of future work in the years to come.
The road to recovery isn't a straight shot
So there's good news and bad news in this report. The good news is that revenue and utilization rates are on the rise. This means that drilling activity is up and Ensco is finding enough work to replace rigs rolling off contract as well as deploy previously idle assets. This bodes well for the company on the slow march back toward profitability.
The bad news is that the rates for those contracts are way down from where they were a few years ago. For Ensco and others, this will likely mean that margins over the next couple years will be incredibly tight and aren't likely going to get to the same levels we saw from 2010-2013. With utilization rates for Ensco and others around 60%, the bargaining power is still in the hands of the customers. Until we see utilization rates north of 80% again, chances are the company is going to have to take these slightly less favorable contracts just to offset costs and keep some form of cash coming in the door.
The foundation for a recovery in the offshore rig industry is there, and the valuation of Ensco does make it an attractive-looking stock. That said, investors looking for a payout shouldn't wait with bated breath because it's going to take a long time for Ensco's profitability to recover.