Shares of offshore rig companies Ensco (NYSE:ESV) and Rowan Companies (NYSE:RDC) dropped 37.2% and 39.5%, respectively, in December, according to S&P Global Market Intelligence. Even though the two companies released good news about new rig contracts, the broader market sell-off and declining oil prices weighed heavily on both companies' stocks.
It's unsurprising that the two stocks moved almost in lockstep with each other last month, because Ensco announced back in October that it would acquire Rowan in an all-stock transaction. There has been little indication that the two won't go forward with the deal, so it's more or less a foregone conclusion that this deal will happen.
A lot of this past month's decline will probably have to do with declining oil prices. Offshore drillers like Ensco and Rowan generate all of their revenue from oil and gas producers' capital expenditures. Offshore oil drilling is particularly sensitive to oil prices, because offshore sources tend to be more expensive on a per-barrel basis and can take years to develop. So it takes sustained periods of higher oil prices for offshore drilling to thrive.
Even though we saw drilling activity start to pick up in 2018, this most recent drop in prices may have some investors concerned that any sustained recovery in capital spending could be delayed even further. If that is the case, then offshore producers could continue to produce uninspiring earnings results for some time.
It's still unclear whether this recent drop in oil prices is just a blip in the industry's recovery or if this is potentially a long-term concern. Both Ensco and Rowan announced several new contracts for its rigs in December that should help to boost revenue and hopefully get both companies on track to generate positive earnings results. What the combination of the two companies means for investors isn't entirely clear yet, and the volatile nature of oil prices makes it harder and harder to understand the industry.
The encouraging thing for investors looking further down the road is that shares of both companies are incredibly cheap right now. Ensco's and Rowan's stocks trade for less than 25% of their book value. This is a cyclical industry, and long periods of low capital spending tend to lead to undersupply further down the road, which tends to result in higher prices. When the cycle turns and producers start spending on offshore exploration again, buying shares today have the potential to be incredible value stocks.