Stock Analysis: Ensco (ESV)

Notes:
Stock Ratings: 1 = buy at current stock prices, 2 = buy on a 5-10% dip in stock price, 3 = sell on a 5-10% increase in stock price, 4 = sell at current stock prices to raise cash.  Ratings are based upon 12-18 month outlook on stock direction and not necessarily related to moves I make due to financial positioning.

Post was edited to correct a mistake.  All references to Slumberger were meant to be Transocean and the post has been changed to reflect this.

Ensco is an Oil and Gas under water drilling equipment supplier which I'm investigating as a potential position in my portfolio.  Essentially, this is one of the top 3 drilling rig platform producers in the world.  Key competitors are Transocean and SeaDrill.  The drilling industry has been under a lot of pressure over the course of 2014.  

Ensco and all of it's major competitors are down 9% or more on the year.  I've noticed a couple drivers for this.  First is demand for the rigs.  This appears to be tight and competitive.  Demand isn't as high because exploration results haven't been as positive as late as well as the fact that oil prices have been relatively flat on the year in the low to mid nineties (WTI). Drilling was subdued from normal levels in both the Gulf of Mexico as well as off the Brazil coast.  Most other off-shore locations were relatively flat.  With this lowered demand, gross margins are also down from normal levels.  This has had an impact on earnings and revenues performances, however, it hasn't been enough to keep the companies from growing.  The second factor I'm noticing is the analyst sentiment.  This is most definitely down.  There have been numerous downgrades from the analysts in the industry.  The fear driving these actions is related to the number of new rigs coming into the space.  It appears that all of these major competitors have been introducing new rigs into their aging fleets and with an increase in supply of rigs, you get less demand pressure to increase the day-rates these companies charge for their rigs and services. 

A little more specific to Ensco, while a globally diversified company, they have a lot of focus in both the Gulf of Mexico and off the coast of Brazil.  Both of these areas have slumped, but are showing signs of picking up as of their second quarter release.  Mexico has already committed to increased exploration in the Gulf while Brazil has been flat, but shows promise with an upcoming presidential election that could be a catalyst to expanding oil production in that region.  Despite these challenges, the company still is growing its earnings and revenues at a respectable clip while beating both top and bottom lines in the second quarter.  Cash flow is strong enough to pay for all of their 6% dividend yield and this is in spite of payments for new rigs which is expected to continue until 2016.  Balance sheet is strong with $1.7 Billion in cash and $18.2 Billion in assets compared to the $4.6 Billion in long-term debt.  They are in the process of selling some of their rigs and already have the second youngest fleet in the industry.  As such, most capital spending is already accounted for and they are well positioned for future growth as well as being positioned to get through some of the challenges the industry faces with aging fleets.  My prediction is that a number of rigs owned by other companies are going to have to be sold or scrapped and this should help reduce supply concerns.  Only problem is that we're not seeing the action to support the thesis yet and with a number of companies creating their first rig, the supply concern continues to haunt the group.  

The stock currently trades at just 8.75 times 2015 earnings expectations, whereas 16 times earnings is more the norm.  This give the stock lots of room to run and with its aforementioned 6% dividend yield that appears maintainable, you're provided with solid support to prevent the stock from going too much lower.  On the year, the stock consistently appears to find support when it reaches around the $47 mark.  Currently it's just over $50.  I would say the stock has limited down side, with some decent upside potential.  Brazil continues to be a risk as are oil prices.  While the stock has been climbing lately, it's been on weak volume.  Come September, we should be able to start getting a feel whether or not this is a stock that will start to get some love this fall, or if it stays beleaguered for the rest of the year.  If the latter, I expect the stock will continue to find support around $47 and will pay you to wait until things do finally turn for the better.  It's also likely possible that ramp-up begins this fall as people look for high-value opportunities.  There's no doubt you're taking a chance on a beaten down industry and stock.  If concerns of oversupply do start showing up, the stock will get hurt more, however, it appears the risk is well in check at this point and there's enough upside potential with a strong dividend reward to make this something worth going for.  I believe any price below $52 is worthy of some nibbling.  Under $50 is a flat-out buy.