For underpriced ESV, no place to go but up

January 18, 2018 02:00 PM

With a market cap of $2.6 billion, Ensco (ESV) is a leading marine driller with a fleet of 63 rigs, which includes 12 ultra-deepwater drillships. Ensco’s stock price is near its cyclical low. It has a 12-month upside target of $7 per share (+12%) assuming its seven-year average 6.3x cash flow multiple on depressed 2018 estimated cash flow of $1.07 per share. It has substantial earnings growth potential thereafter. At the peak of the marine drilling cycle in 2013, the stock hit a high of $66 per share.

The completion of Ensco’s acquisition of Atwood Oceanics in October added four ultra-deepwater drillships: two active and two under construction. ESV issued 134 million shares to Atwood shareholders with a value of $782 million in an all-stock transaction. Annual synergies of $65 million from 2019 are expected.

Floating rigs will generate about 63% of ESV’s 2017 revenue; the rest will be generated from jack up drilling rigs, common to offshore drilling. ESV has a $3.2 billion contract revenue backlog. Its $1.1 billion 2016 cash flow from operations is expected to decline to about $300 million in 2017, and increase modestly in 2018 with the Atwood acquisition. 

ESV’s cash flow peaked at $2.2 billion in 2012, and its current fleet could generate comparable cash flow in the next industry up-cycle from 2019 and beyond. Capital spending peaked in 2012 at $1.8 billion. ESV is down 48% in 2017 through November compared with a 30% decline in the OIH oil services ETF. 

ESV reached a cyclical low of $4 per share in August; its cyclical high was $66 per share in Q1 2013. At its high, it was selling at 10.8x 2013 EPS and 7.7x 2013 cash flow from operations.

While ESV stock has been declining in this difficult environment, there are signs of change. During the last 12 months, more operators in all markets are placing increased emphasis on drilling contractor’s financial stability.

About 20% of global supply is owned by established, well-capitalized drillers. They have won over 35% of new contracts awarded this year. 

ESV is a compelling value with a substantial out-year upside; it is a substantially underpriced stock. The replacement cost of its modern high-spec fleet is 2.8x larger than its current enterprise value pro forma the acquisition of Atwood. Oil prices are likely to dip lower in coming weeks with a build in surplus inventories from a seasonal Q1 2018 decline in global demand and acceleration in the growth in U.S. oil production from Q2 2018. Beyond 2019, the risk of an oil shortage is high. And marine drillers like Ensco typically track oil prices. A better buy opportunity in ESV could emerge in response to a near-term dip in oil prices. Also, offshore costs have fallen substantially since the downturn began and new projects are now economic at current oil prices.

Ensco hit a major bottom in August and appears to be in a good position to take advantage of a better environment for offshore drillers.   

About the Author

Paul Kuklinski is the founder of Boston Energy Research. He also was a partner at Cowen & Co. and a founding partner of Harvard Management Company.