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Ensco International -- 20% Cash Flow Yield and Incredible Balance Sheet

July 01, 2010 | About:
Canadian Value

CanadianValue

209 followers


I've been attracted to the carnage in the offshore oil industry brought on by the BP disaster and the recent stock market decline.

I'm interested in Ensco (ESV) and have initiated a small position.

I'll run the numbers quickly to show why I'm interested and then follow up later with more detail.

Current mkt cap is $5.6 bil (this is at $40 per share)

Average cash flow from ops over the past 3 years is $1.2bil (this actually won't decrease going forward as new high rate ultra deepwater rigs have been added to the fleet and aren't picked up in much of this number).

Maintenance capex is $200mil (vast majority of recent capex has related to building out ultra deepwater fleet).

Free cash flow is therefore $1.2bil - $200mil = $1bil.

$1bil of free cash flow / $5.6bil mkt cap = 17.85% free cash flow yield

However this ignores the fact that Ensco has $1bil of net cash on it's balance sheet.

So enterprise value is actually $5.6bil - $1bil = $4.6bil

Free cash flow yield on enterprice value is $1bil / $4.6bil = 21% plus.

Some other considerations:

1) Drilling Moratorium

Ensco fleet is

8 jackups in the GOM (these service less than 500 feet so not subject to moratorium issues)

3 Deepwater semis (these could be impacted by moratorium)

5 Mexico jackups

8 Europe jackups

2 Mediterrean jackups

8 Middle East and India jackups

8 Asia Pacific jackups

1 Asia Pacific Deepwater Semi

1 Asia Pacific Barge Rig

4 Deepwater semis under construction

So the 3 deepwater semis could have issues once their contracts expire, but can be moved elsewhere in the world.

Be sure to note that there are 4 additional deepwater rigs coming on in the next few years. These will have the most modern safety measures, will attract very high rates, and will add to the cash flow figure I've used in this analysis.

2) Shareholder friendly

Current dividend yield of 3.5%

Repurchaser of shares

3) Recently moved to the UK

Will lower effective tax rate to 17% which is not modelled in my cash flow figures

I started in at $35 and was hoping for continued selling. I think it is still a very attractive buy and will add to my position if it sells down again. I'm determined to be patient

About the author:

CanadianValue
http://valueinvestorcanada.blogspot.com/

Rating: 4.2/5 (19 votes)

Comments

Adib Motiwala
Adib Motiwala - 4 years ago
I have no way of knowing maintenance v/s growth capex. I usually compute FCF = OCF - Capex. and owner earnings ( another alternative) = net income + amortization / depreication - capex.

Those numbers come out to 377 million and 155 million respectively.

However, i did computer the average earnings over 10 years and the P/E of that is 12.9 which seems ok compared to the market multiple. Is P/E the best way to look at this industry.
CanadianValue
CanadianValue - 4 years ago


"I have no way of knowing maintenance v/s growth capex. I usually compute FCF = OCF - Capex. and owner earnings ( another alternative) = net income + amortization / depreication - capex."

Ensco provides that information. The growth capex is the majority as it relates to cash that has gone into their new ultra-deepwater fleet. The spending on these is 70% complete and the incremental revenue has yet to be realized as they are just beginning to be deployed.
Sivaram
Sivaram - 4 years ago


ITCONSULTANT: "However, i did computer the average earnings over 10 years and the P/E of that is 12.9 which seems ok compared to the market multiple. Is P/E the best way to look at this industry."

Some people would disagree with me but I personally don't think a low P/E necessarily means a stock is attractive if it is a cyclical industry. The strategy I follow is to consider cyclical stocks as attractive when the P/E is really high (or infinite/negative.) There are some exceptions of course (usually the rule doesn't apply to distressed companies.)

Don't know much about this company but this definitely looks like a cyclical company (the whole energy complex is generally cylical except pipelines/utilities/etc.) So a low P/E doesn't really mean it's more attractive. The P/E you suggested isn't very low but it isn't very high either. Without doing any research I would say that this likely implies the company is neither very expensive nor very cheap.

If you look at the 10 year P/Es for this company, you'll see what I mean by 'low p/e=bad' for cyclicals. The 10 years of P/E, either found at GuruFocus or Morningstar, shows that ESV had a P/E of 3.5 in 2008 and 69.9 in 2002, while the TTM is 8 (according to Morningstar.) Counterintuitive it may be but the worst time to buy ESV was in 2008 when its P/E was 3.5. That was when it hit a multi-year peak price and, if my bearish view on oil is corret, it may be a multi-decade peak as well. I didn't look up the chart but buying it at a P/E of 69.9 in 2002 was probably much better.

Having said all that, if you are pure value investor, what happens to the P/E ratio may not mean much. If you can do very good fundamental analysis and pick really good companies, the cyclicality of the P/Es doesn't matter. The P/Es are cyclical because earnings are cyclical (usually because commodity prices aren't stable) but the best companies or really undervalued companies will create profits no matter what. For example, ExxonMobil is one of the best perfomring stocks in the last few decades even though, until the 2000's, we were in a very bad bear market in commodities.
richday101
Richday101 premium member - 4 years ago
I look at P/Es but only if the company has stable EPS. I prefer to use the sum of all future cash flows to calculate intrinsic value and then see if the company sells as a high enough discount. GuruFocus has a very nice calculator which can be used to calculate the sum of EPS or CFs for valuation. Several other intrinsic value calculators are available and its best to look at several valuations. I would not buy an oil driller unless it was selling for at least a 60% discount. A quick analysis shows most of the drillers are selling for huge discounts presently. I have not looked at ESV but like NE (Noble Energy) and RIG (Transocean).
CanadianValue
CanadianValue - 4 years ago


"Don't know much about this company but this definitely looks like a cyclical company (the whole energy complex is generally cylical except pipelines/utilities/etc.) So a low P/E doesn't really mean it's more attractive. The P/E you suggested isn't very low but it isn't very high either. Without doing any research I would say that this likely implies the company is neither very expensive nor very cheap."

I think P/E would be a very bad metric to use for evaluating a company like Ensco. The reason is that they are depreciating their rigs on the income statement, when in reality these rigs hold their value very well and often appreciate in value.

As far as cyclical. That is undoubtedly true. You have to have an opinion on the future price of oil. And in my mind it is a no-brainer that oil is going to average $75 plus in the decades ahead. World oil demand is going to increase relentlessly as the 3 billion people in Asia go from having 15 cars per 1000 people to considerably more as their countries develop (North Americans have 700 plus cars per 1000) people. At the same time the world is having a very difficult timing raising production above current rates. So increasing demand. Decreasing or at best flat production.

I write about it here. http://valueinvestorcanada.blogspot.com/
ccyork
Ccyork - 4 years ago
ESV:

- is trading close to tangible book value

- has a rock-solid balance sheet, with a mountain of cash

- is one of the best companies in it's industry

- pays a large dividend

- is currently out of favor

- is worth taking a close look at

CanadianValue
CanadianValue - 4 years ago


"ESV:

- is trading close to tangible book value

- has a rock-solid balance sheet, with a mountain of cash

- is one of the best companies in it's industry

- pays a large dividend

- is currently out of favor

- is worth taking a close look at"

I think the combination of a big free cash flow yield, dividend, share repurchase, and incredible balance sheet kind of says it all doesn't it.

ESV has the stink of BP on it as do all GOM operators (although they are actually fairly diversified across the globe).

But the rest of the world is still drilling, and we will be eventually again as well. We have to. The world's oil production is declining as demand is growing. It is a bad combo.
richday101
Richday101 premium member - 3 years ago
$1bil of free cash flow / $5.6bil mkt cap = 17.85% free cash flow yield.

It appeasr if you use GuruFocus values you get a much lower value for FCF yield. If you take the FCF TTM value of $1.42 and divide by price of $43.74 you get FCF yield of 3.2%. If you look at the last 3 years free cash flow (years ending Dec '07, '08 and '09 you get average FCF equal to $ 3.39 (i.e. [4.98+2.63+2.55]/3 = 3.39). Dividing by a price of $43.74 you get a FCF yield of 7.7%. Both values are far off your FCF yield figure of 17.85%. Who is correct?

Adib Motiwala
Adib Motiwala - 3 years ago
Hi

I had the same initial concern. However, if you read the 10k you will see the break up of the capex. Most of the capex is for new rigs ( growth capex). So, the maintenance capex number is what is used in the article. I agree with CanadianValue's numbers.

Thats why it makes sense to always check the 10k for financial statements and foot notes.
richday101
Richday101 premium member - 3 years ago
Thanks, Adib Motiwala.
rgosalia
Rgosalia - 3 years ago
Ensco (or any contract drilling company) is a case where looking at historical data is insufficient. Understanding the industry economics is crucial to understand the risk/reward.

Crude oil price went from $70 on June 29, 07 to peaking at 145$ on July 4 and then back to 79$ on Dec 31, 09. During this period, the supply for jackup rigs (which is a large portion of Ensco's revenue and fleet) was very tight due to super high drilling activity by the E&M companies. Also, contract drillers all over the world ordered new rigs to be delivered in the 2010-2012 time frame expecting the trend of high oil prices to continue. Day rates and utilization for Ensco was super high. Also, since they had one of the newer fleets at that time, they commanded higher margins than the rest of the industry.

Now, industry conditions going forward are completely different. All the new jackup rigs ordered during the peak prices are going to add to supply for the next few years. Most of these rigs are uncontracted, so the owners, specially the ones at margin, are going to be quite desperate to get them contracted. As Ensco's contracts reset its day rates will be much lower than the 2007-2009 range, probably close to 50-80K day rates compared to the 100-150K range for 2007-2009. Also, Ensco going forward may not be able to compete on age of the rigs because its competing with the newbuilds, and hence may not have the same margins.

I just want to warn readers about using historical data to conclude how cheap the stock is, without paying attention to the actual business and the economics of the industry it operates in. Having said that, Ensco is still cheap, but not because of how all the ratios based on historical data make it look so cheap. Its because Wall Street is currently putting very little value on its deepwater operations. It will add another 2-4$ through deepwater through its new builds (provided deepwater operations are not permanently closed in GOM similar to what happened after the Three Mile accident) that will more than offset the possible decline in day rates for jackups in the next 3-4 years. I believe that the chances of permanently closing down GOM for deepwater operations is not very likely, given that US gets 30% of its US produced crude oil from GOM , and most of it is expected to come from deepwater going forward.


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