September 29, 2016

Markets Are Pricing Ensco To Sink, But Its Ability To Stay Afloat Spells Potential For Equity Upside


Summary:

  • At $7.46 per share, ESV’s 17.7% Adjusted ROA and 0.8x Adjusted P/B drive an 11.8x Adjusted P/E, which set it up as an interesting cross-capital idea given its fundamentals.
  • Investors appear concerned about ESV’s ability to navigate challenging macroeconomic conditions in the energy market, with credit markets particularly concerned about the firm’s balance sheet and liquidity.
  • Not only are concerns about ESV’s profitability overblown, the firm also boasts a robust recovery rate, substantial cash balances, and a multi-year debt runway for navigating any credit issues.

Ensco plc (NYSE:ESV) is in the Oil and Gas Drilling & Exploration subindustry of the Energy sector. Its stock price is $7.46 as of September 9, 2016, with a market capitalization of $2.2bn. Ensco is traded on the NASDAQ exchange with headquarters in London, United Kingdom.

To better analyze the company’s performance and valuation, we used the Valens-Research.com database, as it is difficult to make investment decisions without using performance and valuation metrics that have been adjusted for distortions and inconsistencies in financial statement reporting under both GAAP and IFRS. (For more detail, please follow this link.)

After careful analysis of both historical trends, as well as current valuations and analyst estimates, we believe the embedded expectations of ESV make it a very interesting cross-capital idea.

At $7.46 per share, Ensco has embedded expectations of future performance that are excessively low relative to historical performance.

Based on the firm’s stock price of $7.46, market valuations are pricing in ESV to see Adjusted ROA decline to 4%-5% over the next five years, with neutral 5-year CAGR (compound annual growth rate).

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What the market is thinking and why

Ensco provides offshore contract drilling services to the worldwide oil and gas industry through three segments: Floaters, Jackups, and Other. The firm owns and operates the second largest fleet in the world, with 68 offshore drilling rigs.

Ensco’s stock price has been hit dramatically since the oil downturn began in late 2014. While drilling and exploration companies of all kinds have been negatively impacted by the downturn, offshore rig lessors have taken the biggest hit. Offshore rigs tend to be the highest levered of their drilling peers, and cannot easily alter operations to reduce costs and de-leverage. Also, thanks to the cost of some of the larger rigs and the more complicated environments they operate in, they can sometimes be at the higher end of the cost curve, pressuring demand. Additionally, in an oversupplied market, E&P customers are in an excellent negotiating position to drive down day rates, further impacting the revenues of offshore drillers.

On top of macroeconomic concerns, investors have been further spooked by the explosion in Ensco’s CDS and cash bond market spreads, with their CDS trading at 573bps as of this writing, and their 2021 4.700% bond trading with a cash bond YTW of 8.009%. With these kinds of credit market spreads, markets appear to be pricing in a 10% 5-year chance of default, raising significant concerns for equity investors.


Click here to read the article in its entirety at Seeking Alpha, where you will find out why the market is wrong, what our target price range is for ESV, and what the possible catalysts are for the market to revise its expectations for the company.