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Diamond Offshore or Ensco? Maybe both?

July 31, 2010 | About:
CanadianValue

CanadianValue

209 followers
I’ve written previously about Ensco as being an attractive investment opportunity at or near the current share price. Here is the article:


http://www.gurufocus.com/news.php?id=98829


I’ve also looked at Diamond Offshore recently and there is a fairly large valuation gap between the two companies. Here are the numbers:


Diamond Offshore - Cash flow after maintenance capex $1.1bil.


Ensco – Cash flow after maintenance capex $1bil


Diamond Offshore Enterprise Value - $9bil


Ensco Enterprise Value - $4.6bil


That is a pretty striking difference. Cash flow from each business is roughly the same. But Ensco is basically half as expensive as Diamond Offshore.


And interestingly Ensco is sitting with $900 million dollars of net cash on it’s balance sheet while Diamond Offshore has net debt of rougly $700mil.


I’m not saying Diamond Offshore is expensive, but rather that Ensco is exceptionally cheap especially given that it has a much better balance sheet.


Here is what David Einhorn said recently in his quarterly letter about his new position in Ensco:


Ensco plc (ESV) in an offshore contract oil drilling company operating a large fleet of shallow-water jack-up rigs and a small but new fleet of deep water rigs. The Deepwater Horizon oil spill and resulting 6month drilling moratorium in the Gulf of Mexico caused significant share price declines throughout the sector. ESV was not involved in the horrible accident, which should not materially impact the company’s long-term potential. ESV has approximately $7 per share in net cash and a tangible book value of $37.50 per share. The shallow water drilling business, which is unaffected by the drilling moratorium, generates $4.00 per share in en-levered mid-cycle earnings and $8.00 per share in peak earnings. At the Partnership’s average cost of $39.41 per share, we appear to be getting the shallow water fleet at a low value and the deepwater fleet (in which ESV has thus far invested over $15 per share to build and should add $2.00 and $4.00 to mid-cycle and peak EPS respectively) for free. ESV shares ended the quarter at $39.28 each.”


With the BP Macondo well now seemingly under control the fog may be starting to clear from around Ensco, Diamond Offshore and other drilling related companies. Friday the House of Representatives voted in favor of ending the drilling moratorium. And the signs of the oil spill in the Gulf of Mexico are already disappearing. The world and the United States in particular will need as much oil as possible over the next ten years. The rigs of Ensco and Diamond Offshore are going to be in great demand as we push forward into the Deepwater as one of the last sources of new oil. With Ensco’s balance sheet there doesn’t seem to be much risk at a $40 stock price and there certainly seems to be a great deal of upside.

About the author:

CanadianValue
http://valueinvestorcanada.blogspot.com/

Rating: 3.7/5 (9 votes)

Comments

Adib Motiwala
Adib Motiwala - 3 years ago
HI Canadian Value,

Good post.

Currently, ESV EV = $5010 millions and not $4600 million

obviously, ESV has a much better balance sheet than DO and more importantly on a Price/ Tangible book basis, ESV is much cheaper than DO. ESV trades at 1.1x v/s DO that trades at 2.3x tangible book value.

An additional metric I look at is EV / OCF. DO trades at 6x and ESV at 4.9x (ESV is cheaper)

However, DO is not that expensive either with a P/FCF = 7.5x.

ESV trades at 6.1x FCF ( if you take the maintenance capex as $238 million from the $861 million they spent in total capex in 2009

Capital expenditures on continuing operations:

New rig construction $ 623.4 (growth capex)

Rig enhancements $ 153.1 (maintenance capex)

Minor upgrades and improvements $ 84.8 (maintenance capex)

--------------------------------------------------------------------------------------------------------------

Total capex $ 861.3

2009 Total mainteance capex : $238 million

2009 OCF : $1221 million

FCF = 983 imillion.

P/ FCF = 5980 / 983 = 6.1x


CanadianValue
CanadianValue - 3 years ago
Thanks for the comment.

I think you are right, both of them are cheap. And I don't think there is much long term impact to their business from the BP spill either.

I'd love to have Ensco trade down a little further so I can keep buying.

You can likely throw Transocean and Noble into the mix as well.
softdude2000
Softdude2000 - 3 years ago
Whether it is RIG, DO, noble or ensco...do they have any durable competitive advantage? Or is it just taking some advantage of mispricing in off-season down market? I already read there are many fleet coming and day rates will fall. How can we analyze if they have any pricing power in future like 10 years.
Adib Motiwala
Adib Motiwala - 3 years ago
Excellent question. The question about utilization rates and day rates is of utmost importance here. These rigs are usually on longer term contracts. However, recently softness has been seen on both fronts for the jack up rigs. However, the semi-submersible rigs will help soften the blow to the revenues and maybe help increase it.
softdude2000
Softdude2000 - 3 years ago
My concern is all these businesses are throwing out good operating cash flow and that big cash flow is reinvested to buy new fleet and that new fleet will cut down prices. Looks like their growth/profitability is their problem.
softdude2000
Softdude2000 - 3 years ago
The way to justify investment in these companies to show future demand profile and compare with supply of rigs (which is very tough); not p/b ratio and not past p/cf ratio.
Adib Motiwala
Adib Motiwala - 3 years ago
I went through their 10k. What ESV has done is invest a significant OCF into building new rigs. These rigs are the semisubmersible deepwater rigs. The demand for these rigs is much high and outstrips supply. The day rates for these rigs is $400k-$500k. The day rates for the jack up rigs ( which was 87% of their revenues till end of 2009) has been falling as well as the utilization rate. A lot of supply will come on board this year for both types of rigs. However, ESV is not building any more of jackup rigs as they have 42 of them.

ESV has 4 deep water rigs and 4 more are under contstruction. these rigs should add considerable revenue and earnings starting next year. One of these rigs comes online 4q 2010.

the business is cyclical however its not as bad as the refineries like Valero which went from about $8 eps in 2007 to -4 eps in 2009.
rgosalia
Rgosalia - 3 years ago
"My concern is all these businesses are throwing out good operating cash flow and that big cash flow is reinvested to buy new fleet and that new fleet will cut down prices. Looks like their growth/profitability is their problem."

Ensco made 4853.7$ million in cash flow from operations from 2005-2009. Out of this, it spent:

  • 18% on making enhancements and maintaining its existing fleet,
  • 46% to purchase new semisubmersible rigs,
  • 21% to return cash to shareholders either through dividends or through stock repurchases,
  • 5% to retire long-term debt,
  • and remaining accrued to cash & cash equivalents on the balance sheet.
The enhancements and maintenance allowed them to have higher gross margins on the jackup rigs business than the competitors and the new rigs helped them to diversify their income stream to deepwater operations. During this period they had one of the youngest fleet in the industry, which helped have lower downtime for repairs and maintenance.

Now, as per industry data (ODS Petrodata), only the jackup rigs are expected to not be absorbed into the market without affecting day rates and utilization. The semisubs were fully expected to be absorbed into the market, until the BP deepwater accident moratorium in the Gulf. Since, Ensco poured most of its cash flow to buy new semisubs, I would argue that the management team has been a very good capital allocator.

"How can we analyze if they have any pricing power in future like 10 years."

In this industry, I doubt if any single player has any significant pricing power. It is a cyclical industry and the one with the strongest balance sheet and the strongest management team is the one that comes out ahead.

Ensco's management team has shown repeatedly that they can adapt to changes. I have read everything on Ensco going back to the late 1990s. Their fleet today looks totally different from then. Ensco early on recognized that they need to transform themselve - they sold all their non-core operations slowly and used the proceeds to upgrade their jackups and buy new semisubs. They were richly awarded during the peak cycle.

Its probably very difficult to guess what they or anybody else in this industry will do in 10 years. I am going with the fact that you are paying below replacement cost and at 10x earnings of a worst case scenario (no income from deepwater and 30% lower income from jackup rigs compared to 2009).

"The way to justify investment in these companies to show future demand profile and compare with supply of rigs (which is very tough); not p/b ratio and not past p/cf ratio"

You are right that ideally you want to know the supply/demand characteristics to know what exactly their future cash flow will look like. Unfortunately, if it were so simple, those expectation would have been embedded into the price and there wouldn't be the uncertainty around the drilling contractors as it exists today. Wall Street hates uncertainty and punishes uncertainty. In my opinion, the only way to analyze Ensco is to look at the history of the management team and to buy the business at below replacement cost. As long as the company has a strong balance sheet, it can withstand pretty much any distress. As soon as the clouds clear, I think Wall Street will start putting a much greater value on Ensco. It may take a long time for the clouds to clear, but as a value investor I don't mind waiting for a few years.

I am just curious - I recently wrote a long article on Ensco very recently and I covered many of the questions that are showing up on this thread. It will help me to know (improvements I could make for future articles) if these points were not clearly covered. I appreciate any feedback.

Adib Motiwala
Adib Motiwala - 3 years ago
Rishi,

your article was excellently written and covered the points in depth. Also, Ravi's article which was posted before yours was superb. Keep up the good work. I am myself writing a short write up and am considering to open a position.

I looked at DO, RIG and NE briefly and all of them had much higher debt / equity. And I doubt anyone has such a high dividend. RIG has $10 billion of debt ( its much bigger). NE took on $1.2 billion of debt recently to fund an acquisition. Considering these facts, I felt ESV was the most attractive one as I see limited downside due to strong balance sheet, high dividend yield and trading at 1.1x tangible book value. Upside case could take a while. Once the deep water rigs come online, the top line and bottom line should grow ( provided day rates and utilization on jackup dont fall further). I dont think we see 50% utilization rates on them.

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