As challenging times continue for the offshore drilling industry, there are attractive opportunities for the near term and medium term.
Ensco (ESV, Financial) is among the major players in the offshore drilling industry, and the company’s stock has been sideways for more than four months now. With a prolonged period of consolidation, there is upside for the stock in the coming quarters.
As I have done for all companies in the energy sector, I will start my analysis with the company’s credit profile. This is the most important part of the analysis in the current industry scenario. Survival is the key factor for companies.
In the last few months, there have been several positive credit developments and the developments and implications are as follows:
- In April Ensco raised $586 million cash through equity offering of 65.6 million shares. This is one of the reasons for the stock moving sideways as there has been dilution of equity. However, cash infusion was critical, and I don’t see this development as negative.
- In April Ensco repurchased $861 million in senior notes at an average discount of 28%. This has helped the company to strengthen its financial position and reduce annual cash interest expense by $45 million. With deleveraging an important aspect in the down cycle, Ensco has done well on that front.
- For the next three years (2016 to 2018), Ensco has no debt maturity, and this implies that there is no immediate pressure for debt refinancing. If industry conditions gradually improve in these three years, Ensco will be well positioned to repay debt maturities on and after 2019 through internal cash flows.
- For the remainder of 2016 and for fiscal year 2017, Ensco has total capital expenditure of $690 million. This investment will be serviced through internal cash flows coming from existing order backlog. Therefore, the company’s credit profile will remain strong in the coming quarters.
- Ensco has a revolving credit facility of $2.25 billion that remains fully available and is maturing only in 2019. This provides additional liquidity buffer and with net debt to capitalization of 33%, I don’t see leveraging as an issue beyond the next 18 months.
With these credit positives, it is not surprising to see Ensco rated BBB with a “Stable” outlook. The company’s outlook will remain stable to positive in the coming quarters.
While I have discussed the positives from a credit perspective, it is also important to mention that worries are far from over for the industry. In particular, I expect significant EBITDA margin compression in the next few years, and this will have implications on the credit profile once the existing order backlog is replaced with new orders as rigs complete their contract term. However, it is safe to assume that the EBITDA compression factor is already being discounted in the stock.
While oil prices might be trending higher, for recovery in the offshore drilling industry sustained recovery is critical along with broader economic outlook remaining positive as oil consumption growth will have implications on the price trend.
While these concerns exist, the stock has been in a prolonged phase of consolidation and a rally is entirely likely as oil gathers some positive momentum. Invest in the stock for the medium term, and profit booking can be considered if the stock trends higher by 10% to 15% from current levels.
Disclosure: No positions in the stock.
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