The collapse of oil prices over the past few months has led investors to flee offshore drilling stocks en mass, and shares of Ensco PLC (VAL) haven't been spared from the fate of competitors. But with the decline in Ensco's stock price comes a potential discount for investors willing to ride out the current negativity built into the market.
But, as with any investment, the risk versus reward is what investors need to look at when analyzing whether Ensco's stock is a buy or not.
Jackup rigs like this one have driven Ensco's profit growth in 2014. Source: Seadrill.
Profits are strong and growing... for now
In the third quarter, Ensco's revenue was up 9% to $1.26 billion, and operating income jumped 22% to $559.6 million, driven by new rigs and a 5% increase in dayrates. Based on those numbers, you wouldn't think there's any problem with Ensco's business.
On top of strong trailing operations, Ensco has $11 billion in revenue backlog in the future. That'll shield the company a little from a downturn in the market, but it doesn't eliminate the pain entirely.
Ensco CEO Carl Trowell said on the company's earnings conference call that low oil prices will lead to challenging conditions in 2015, and probably into 2016. Utilization and dayrates may take a hit, especially for older floaters coming off contract.
Since the stock market is a forward-looking tool, it's no wonder Ensco's stock has fallen despite rising profits in the third quarter. 2015 looks like earnings could reverse course in a big way and decline significantly.
An offshore drillship. Source: Seadrill.
Getting bang for your buck
If earnings are going to decline next year, investors better be getting a good deal on Ensco stock, and on that front, the shares look very attractive. The trailing P/E ratio is just 6.5, and the stock is paying a 7.5% dividend yield, but it would be extremely attractive if market conditions were improving.
The question of the day
Long term, what investors really have to ask themselves is if oil prices will rise above $100 per barrel again. If they do, demand for offshore rigs should improve, particularly in ultra-deepwater, where the industry is betting on a bright future.
If oil does rise, investors are also getting a great deal in Ensco's shares, as I pointed out above. We could even see significant earnings upside as new rigs come online over the next year, which could arguably increase the company's value even more.
But there's certainly a lot of risk in betting on a stock like Ensco right now. I happen to think oil won't stay below $80 per barrel for long, because there are too many countries that need the price to be higher to make their economies go, but that's still a risky bet. I'm holding onto shares, and I think the stock is a buy, but I'm also willing to take the risk that comes along with that investment. It's not a risk everyone should take.
