Stock Analysis: Ensco PLC (ESV)

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.

Last week, Ensco announced their third quarter results, which beat expectations.  Earnings came in at $1.93 and revenues were $1.26B.  The problem and ongoing concern continues with the guidance.  It was stated that the downturn in oil prices started right at most company's budgeting season, and as such, the season has been slowed to to adjust to changing market conditions.  Ensco will not be able to provide any difinitive perspective until the end of the fourth quarter, but they are guessing "than an upturn in demand is less likely before 2016."  This flattening growth is and will continue to be a huge reason for the stock price to falter.  

The offshore drilling has two areas which Ensco focuses on - Jackups and Floaters.  Jackups are meant for more shallow depth drilling and the company reports that demand continues to stay strong here - in fact, demand isn't the problem, but rather supply.  There is a lot of supply in the market, however, a large majority of that supply is via speculators.  So far, companies aren't biting on unproven speculators with their new rigs.  This is positive, however, what happens if prices continue to fall?  There will be a point where margins play a role and if there are speculators running cheaper products, they may be selected.  The alternative is what happens if they don't get selected and go out of business/sell off their assets?  There are 2 scenarios I see here.  First, jackups are auctioned off extremely cheaply to remaining offshore drillers - established ones with balance sheets that can afford to buy them.  This could give Ensco's competition a chance to get rigs much cheaper than ESV has built their own as they try to stay current, though ESV could also be in there buying supply to replace old rigs.  This is a margin risk in the out years (think past 2016 most likely).  The other risk continues to be supply risk.  If other companies do as Ensco and replace older via retirement, and then these rigs go on sale, there will still be a glut of supply and now the supply would be with companies that are successfully making business.  This will cause day rates to go down and will hurt revenues.  So for the short term, we're ok here and this could help provide some strength in a tough market, but there are risks to watch out for as we watch what happens with rig supply in the future.

The second type of rig is the floater.  These rigs are meant for mid, deep, and ultra deep drilling.  The demand here is already dropping rather dramatically.  It was called out in this conference call that companies are being forced to scale back on Capex spend, and therefore the floaters are getting hit due to the higher costs and lower production gains in these low-oil price markets.  This is going to be the primary reason for lack of growth in 2015 if conditions don't change.

The differentiation for this company continues to be its excellent operational efficiencies and the fact that they appear to be well ahead of competitors at getting their fleet upgraded with new technologies that allow their customers to reap better results and be more cost-effective.  This has the potential to help get them wins in a tough market, but that may depend, in part, as to how long it stays this difficult.

Now into my numbers and ranking.  I know I've had this stock at a 1, but I just can't have it there right now.  I know I'm being swayed by current events, but the fact is that Oil is now below $80 a barrel.  Though I can't say I think prices are plummeting further from here, I can't say it's not a possibility.  That being said, the stock did pop after earnings and reach the $40 area I expected it would before these last couple days.  And with the recent drop below $80, the stock prices has yet to have reached or surpassed its 52-week lows.  Add onto that a company that has some of the best margins, revenues ratios, and a dividend payout that they continue to reiterate is safe, there's still potential here if you can be patient.  I'm not convinced that oil prices will stay this low and I personally believe we will start to see other economies begin to pick up in 2015, which are more likely than not to help oil prices rise.  For 2014, I haven't figured out how to predict earnings and revenues based on the info they've provided on the call yet.  But I'll take a guess and see how things go.  I'm guessing, based on the comments, that we'll see fourth quarter revenues at $1.15B and this will translate into earnings of $1.70.  This is down on both numbers sequentially and equates to full year earnings of $6.54.  With the extremely high risk of lower to flat earnings in 2015, I can only give a multiple of 8 on 2014 earnings right now despite the growth we've seen in earnings this year.  That puts my price target at $52 (rounded down) - a huge jump from current prices, but I'll be the first to say this target may be too high if oil prices don't stabilize.  For now, I rank the stock a 2.5 - a flat out hold.  We need to see a sign of a bottom to the stock and oil prices before we make a move to buy.  That may not happen until 2015.  Additionally, we don't have enough proof that prices will stay this low or are going lower and the future is as risky as projected with short-term fears and an invisible future.  If you can take the pain, it's just best to hold for now.  Keep an eye on what's happening both with oil and how the stock reacts to changes in prices.  There will not be a direct correlation, but it should be strong enough to help get a feel for things.