Over the past 18 months, the unprecedented decline in oil prices has continued to reveal companies that provide investors with significant opportunities. This week, our focus is on one such company. Ensco PLC (ESV) is a global provider of offshore drilling services to the petroleum industry. In early 2015, as oil prices continued to decline, Ensco saw the writing on the wall and began cost cutting measures, reducing labor costs for offshore workers by 9% as well as a 15% reduction in onshore support costs. The company has continued its reduction in operating costs, with an additional $15 million to $20 million savings projected for Q4 in contract drilling expenses. Not only has Ensco targeted operational cost savings, it has continued to sign new drilling contracts, with five new contracts signed in Q3 2015. The company has an impressive $6.6 billion contracted revenue backlog and an equally impressive $1.1 billion in cash. With no debt maturities until 2019, combined with its substantial revenue backlog and cash position, Ensco has done a fantastic job of positioning itself for long-term lower oil prices. Over 7% yield is an outstanding return for such a short term, high quality bond that is investment grade, rated Baa2 (with a stable outlook) by Moody’s and BBB+ by Standard & Poor’s. This is nearly five times the yield of a three year U.S. Treasury bond. For the prudent investor, a 3 ½ year investment grade bond yielding about 7.37% makes for a solid addition to a diversified fixed income portfolio. As such, we have marked these bonds for addition to both our FX1 and FX2 portfolios.
About the Issuer
Ensco PLC is a global provider of offshore drilling services to the petroleum industry. For 25 years, the company has focused on operating safely and exceeding customer expectations. It is the industry leader in customer satisfaction, ranking first again for the fifth consecutive year with top honors for 2014 in 10 of 16 categories in an independent industry survey. Operating one of the world’s newest ultra-deepwater fleets and largest fleets of active premium jackups, Ensco has a major presence in the most strategic offshore basins across six continents. Ensco’s fleet includes ultra-deepwater drillships and semisubmersibles, strategically located moored rigs, and the largest number of premium jackups in the world. Ensco rigs have drilled some of the most complex wells in virtually every major offshore basin around the globe. Its customers are multinational integrated energy companies, national oil companies and independent operators. The company manages operations through five regional business units: North and South America (excluding Brazil), based in Houston; Brazil, based in Macae; Europe and the Mediterranean, based in Aberdeen; Middle East and Africa, based in Dubai; and Asia and Pacific Rim, based in Singapore.
The Offshore Drilling Industry
As one might expect, the sharp decrease in oil prices over the last 18 months has also affected the offshore drilling market. Weak demand and a flood of new vessels have made a definite impact on rig rates and on the number of active rigs. Rig rates have fallen sharply over the past 18 months as oil companies cut capital spending, just as dozens of new offshore rigs ordered during the boom hit the market, creating overcapacity. Day rates (what offshore drilling companies charge for the use of their rigs) for the most advanced ultra-deepwater rigs have also shown marked declines from a peak of around $650,000 last year to their current range of $375,000 to $500,000 per day. Rates for jack-up rigs have also fallen to around $160,000 per day, from a peak of $225,000 per day.
The reduction in offshore drilling activity has also resulted in the retiring of older floater rigs as companies seek to reduce their ongoing operating costs. A recent study found that 44 floaters have been retired since Q3 2014. The same study predicts that an additional 100 floaters could be retired by the end of 2017 if attrition rates continue at the same pace as seen over the past 12 months. Ensco has also sold / divested six rigs since September 2014, bringing in more than $200 million in proceeds in Q3 2014. But even with all of this attrition, Ensco is strategically managing its rig fleet, reducing expenses, signing new contracts and maintaining a healthy balance sheet.
Reducing Expenses and Capital Expenditures
In light of continued low oil prices, Ensco has taken steps to streamline its operating expenses. Year-to-year, the company reduced contract drilling expense by 13% from $500 million to $434 million. Ensco expects contract drilling expense to decrease an additional $15 million to $20 million in Q4. Also, offshore labor costs were reduced in Q3 over 2014 levels by 15%, as well as a $57 million annual savings in onshore support costs.
Additionally,Ensco’s capital expenditures will peak for 2015 at $1.65 billion and will decline significantly over the next few years. In fact, for 2016, the company’s capital expenditures will be cut by nearly two-thirds, with a budget of $625 million for the year.
Significant Revenue Backlog and New Contracts
One extremely positive item in Ensco’s corner is the company’s $6.6 billion in contracted revenue backlog, including $2.7 billion for 2016, which will translate into operating cash flow well in excess of $1.0 billion. In addition, even in the face of decreased spending from many exploration and production oil companies, Ensco had a fantastic third quarter, signing five new contracts, three of which are multi-year contracts. These new contracts have added $400 million in revenue backlog.
In addition to these new contracts, Ensco’s newest ultra-deepwater drillship will be starting work on its first contract in Q4 2015, with an outstanding dayrate in the high $610’s. This will give Ensco a considerable margin and will have an even greater impact in Q1 2016 as it will be operating for the entire quarter.
Healthy Ratios and Excellent Liquidity
Ensco has a strong balance sheet, remaining one of the least leveraged companies in the offshore drilling space. Its net debt to capital ratio as of September 30, 2015 was 32%. The company also has solid interest coverage. In its most recent reported quarter, for the nine months ended September 30, 2015, the company had operating income of $1,267.3 million and interest expense of $158.9 million for an interest coverage of 8x.
Also, as of September 30, 2015, it had $1.1 billion in cash along with a fully available $2.25 billion revolver, for total liquidity of $3.25 billion. This amount of liquidity goes a long way in reassuring bondholders, especially in light of the continued lower spending in the offshore drilling space.
Ensco has no debt maturities until this issue matures in June 2019. With continued reductions in its operating expenses, a more efficient fleet, and a steady, incremental increase in the price of oil, Ensco will be able to successfully navigate this temporary downturn in offshore drilling activity.
Ensco also has excellent margins as compared to some of its main competitors.
The default risk is Ensco’s ability to perform. While the offshore drilling market has experienced significant reductions in activity, it is also apparent that excessive costs and inefficiencies crept into the sector with oil at $100+ per barrel. Now, that trend is correcting in light of the pricing pressures in oil over the last 12 to 18 months. Ensco has been intentional and calculating in its cost reductions and fleet management, as well as in its ability to continue signing new drilling contracts. With its healthy liquidity levels and no debt maturities until 2019, the company appears to be strategically positioned to weather the current low price oil environment.
As the offshore drilling industry is highly affected by the price of oil, Ensco remains exposed to the volatility in global oil prices. Although the company’s cost reductions will make the company more efficient and increase margins, an increase in the price of oil will ultimately increase revenues and profits.
These relatively short-term, investment grade bonds, currently yielding 7%, have similar risks, yields and maturities to other bond issues reviewed on Bond-Yields.com, such as the 8.5% Carrizo Oil and Gas, the 7% Accuride, and the 8.25% DynaGas LNG Partners bonds.
Summary and Conclusion
In response to prolonged low oil prices, Ensco has taken prudent steps to ensure the company’s continued profitability. Jay Swent, the company’s recently retired CFO, accurately described the company’s strategy: “We have aggressively managed our expenses and CapEx (capital expenditures) in response to the downturn in the offshore drilling markets, and we will continue to do so. Our strong liquidity and capital position give us greater flexibility to navigate the downturn.” Ensco appears to have positioned itself to not only weather the downturn, but to quickly excel once oil prices begin to recover. Acquiring the company’s June 2019 bonds, with a indicated yield of about 7.37%, provides investors with an opportunity to add great cash flow and solid returns with invest in a remarkably solid company that has expertly navigated an unprecedented decline in oil prices. In light of these factors, we look forward to adding these high quality, investment grade bonds to both our Fixed-Income1.com and Fixed-Income2.com managed income portfolios.
Issuer: Pride International (now Ensco PLC)
Rating: Baa2 / BBB+
Yield to Maturity: ~7.372%
About Durig Capital
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Disclosure: Durig Capital and certain clients may have positions in these Ensco 2019 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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