One of the toughest companies to follow in offshore drilling today is Ensco (NYSE:ESV). The company has a solid balance sheet and good margins, but it has a fairly old drilling fleet and that may come back and bite the company eventually.
While a stock like Seadrill (NYSE:SDRL) is essentially a leveraged bet on the price of oil with tremendous upside, Ensco has less upside potential and potentially even more risks. Here are the three biggest reasons to stay clear of the stock.
Old rigs are starting to hurt
In the fourth quarter, Ensco wrote down $3.9 billion in assets, meaning they had more value on the balance sheet than what offshore rigs were actually worth. This is what happens when you have aging rigs that are less competitive than new rigs in the current oversupplied offshore drilling market. You can see on the left that Ensco has a middle-of-the-pack floater fleet when it comes to age and one of the older jack-up fleets.
A harsh oil price environment is already affecting the company's aging fleet with seven rigs cold stacked in the fourth quarter of 2014 or early 2015. If the oil market continues to struggle more rigs will be cold stacked, reducing a chance of future earnings.
The long-term problem is that if the oil market improves there's a flood of new rigs that will be more desirable than Ensco's aging rigs. The number of newbuilds in the current market that are under construction and on order currently stands at 83 floaters and 118 jack-ups, and as they come into service they'll take contracts that could have gone to older rigs.
Future revenue doesn't look good
Backlog shows what investors can expect in future revenue for offshore rigs. On that front, Ensco could struggle by 2016 if the industry doesn't improve.
2014 revenue was $4.6 billion and 2015 backlog revenue declines to $3.9 billion and in 2016 just $2.8 billion. Since the industry is at a near standstill and competition for new contracts is increasing, profits could dry up by 2016.
Oil prices show no signs of recovery... yet
Eventually, I think oil prices will rise above the $50 per barrel mark they're floating around today. But that could take some time and the industry may be in for more pain before it gets better.
Last weekend I highlighted that rising inventories in the U.S. could lead to plunging prices by the time summer driving season arrives. That's the short-term challenge in the next few months, but looking out a year or two there aren't a lot of reasons to think oil will climb sharply. U.S. production is still growing, OPEC isn't cutting their production, Europe and China are showing signs of economic weakness, and vehicles are becoming more fuel efficient.
If oil doesn't recover to at least $70 or $80 per barrel, spurring more offshore drilling, Ensco may be holding on to survival due to its old fleet and shrinking backlog. I simply think there's too much uncertainty for Ensco and competitors with greater upside (Seadrill) if the market recovers to be bullish on shares of Ensco right now.
Travis Hoium owns shares of Ensco and Seadrill. The Motley Fool recommends Seadrill. 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.