Ensco (ESV, Financial) reported third-quarter results on Oct. 28, and the results did not disappoint considering the challenging market conditions. These are the key points in the results, the near-term outlook for Ensco and the reasons to consider small exposure to the stock on every correction.
Ensco had declined to $13.5 on Oct. 1. In the next  month, the stock trended higher by 23% to current levels of $16.63. This is significant for two reasons. First, from oversold levels, there is bound to be a strong bounce back, and investors should use such opportunities for medium-term gains. Second, Ensco has discounted the concerns that will sustain in 2016 as oil prices remain low.
Coming to the key points in the results, Ensco has generated $1.3 billion in cash for the first nine months. While operating cash flow has declined as compared to 2014, cash generation still remains robust on the back of strong order backlog. The important point to note here is that Ensco has an order backlog of $2.7 billion for 2016, and this will ensure strong operating cash flow in the coming year that can cover for the company’s capital investments. The point I am trying to make is that Ensco remains fundamentally strong and I don’t expect debt to increase as strong order backlog continues to infuse cash.
From a capital expenditure perspective, Ensco has $625 million investment due in 2016 and $555 million in investment due in 2017. This implies total capital expenditure of $1.2 billion over the next two years, and Ensco already has cash and short-term investments of $1.1 billion. In other words, the company is fully funded for the next 24 months.
In addition, an order backlog of $2.7 billion for 2016, and $1.8 billion will ensure that strong operating cash flow continues. More importantly, the backlog will ensure that debt servicing is smooth in the coming years. I expect the company’s order backlog for 2017 to improve from current levels of $1.8 billion. However, it is still too early to discuss 2017 in detail.
Besides having $1.1 billion in cash and equivalents, Ensco also has $2.25 billion in unused credit facility that is maturing in 2019. This cash will be utilized once industry conditions witness sustained improvement. Ensco isn't likely to increase leverage at this time. The key point here is that Ensco has strong financial flexibility, and, with no debt maturity until 2019, the company has no debt refinancing pressure.
Considering these factors, it is not surprising to see Ensco rated BBB with Diamond Offshore (DO, Financial) being the other company among offshore drillers to be rated BBB. I believe that, with the current order backlog, liquidity and leverage, Ensco is well positioned to maintain its credit rating at current levels.
Another strategy that is likely to generate cash for Ensco in the next 12 to 24 months is the sale of rigs. In the last 12 months, Ensco has sold six rigs, and the company still has four floaters and two jack-ups classified as assets held for sale. The sale of relatively older rigs reduces the weighted average age of the company’s fleet and also provides cash inflow for investment or debt reduction.
Considering these factors, I believe that Ensco will remain fundamentally strong, and the company will continue to generate robust cash flows. Therefore, any correction in the near term would be an opportunity to consider the stock for medium- or long-term investment.
The oil price outlook remains largely uncertain, and investors should avoid big exposure to the offshore drilling sector. However, small exposure on declines is likely to generate robust returns as has been the case in October with Ensco providing 23% returns.
