There are only a few times each year when investors get to hear directly from management about how a company's operations and plans for the future are coming along. One of the most important of these occasions is the conference call following earnings reports.
For Ensco PLC (NYSE:ESV), this is a time to update investors on the offshore drilling market, contracts, industry trends, and plans for the future. This is important in offshore drilling because it's a business that can change rapidly, and Ensco's second quarter call gave some key insights for investors.
Operating in a challenging market
"In terms of the deepwater market, a significant number of new drillships and semis are being built, and customers have tightened CapEx spending, which together are pressuring the supply/demand dynamics. Therefore, it's hard to predict the length and depth of the current downturn in the floater market."-Carl Trowell, CEO
This is the macro challenge for all offshore drilling rig owners. Oil and gas explorers have cut back on drilling because they're seeing lower returns and are less willing to take risks in search of oil; that's created the weakness in rig contracts in 2014.
Eventually, demand will return to the industry, but it's unknown how long that will take. In the meantime, offshore drilling companies, including Ensco, are upgrading fleets with the latest technology and safety features to replace aging rigs in their fleets. This increases supply and makes older rigs even less competitive.
Old rigs are becoming a drag for the industry
"With customers preferences for newer rigs that provide drilling efficiencies, with less capable floaters challenged to find contracts in the current environment, many of these floaters may face extended periods of time without work."-David Hensel, SVP of Marketing
The lower overall demand for drilling rigs is a macro challenge for Ensco, but there's also a bifurcation developing in the market with newer rigs commanding strong demand while older rigs are struggling to find work. This is what David Hensel was referring to, and the negative trend has already started to show itself at Ensco.
Write-downs have begun
"We concluded that we will sell five of our floaters which are now included in discontinued operations. Four of these rigs, with an average range of 37 years had a loss on impairment. The rigs we intend to divest are mostly older, mid-water semi subs that we believe do not have a place in our long-term fleet structure. After this action, our remaining floater fleet will have an average age of just nine years."-Carl Trowell, CEO
The bifurcation I just mentioned has already had an impact at Ensco, as indicated by the intention to sell five rigs.
In time, many of thee older rigs in the fleet will be sold or scrapped, which could become a major problem. Eight Ensco rigs were taken out of service last quarter alone, and with 32 rigs older than 30 years old there's a risk that more rigs will be written off and rigs currently generating revenue will be taken out of service.
Jackups have yet to see a downturn
"Please note that as part of our fleet review process, we did not impair the value of any rig in our jackup segment."-Carl Trowell, CEO
Ensco has written off rigs to make its floater fleet younger but 27 out of 42 jackup rigs are over 30 years old and may soon have to be retired.
These jackups are currently generating strong revenue and because of their age they're also generating strong margins, helping Ensco's profitability. But long-term, these rigs will become less competitive and may have to be sold or scrapped, which would be a negative operating impact. Beware of this when looking at Ensco versus competitors with younger fleets.
"Through collaborative interaction with customers, Ensco has been able to develop unique rig designs with significant technical advantages which coupled with proven operating systems, deliver greater efficiencies and overall cost-savings to customers."-Carl Trowell, CEO
To adjust to the realities of today's market, management is adjusting by acquiring three new drillships and four new premium jack-up rigs in the next two years. Management says that its designs are superior to competitors, which are also building new rigs, and should hypothetically lead to stronger margins.
The fact that Ensco is focusing on differentiating itself with new rigs is good news for investors, but it's still facing headwinds because of its aging fleet. Keep an eye on the drilling market overall because Ensco and many others need demand to pick up or they'll have to begin writing down more rigs, particularly jackups. That's the risk for investors despite the investment in new drilling rigs that should see strong demand.
Travis Hoium manages an account that owns shares of Ensco. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.