Ensco (ESV) Q2 2008 Update

All results US$ unless otherwise noted:

  • Through the 1st half of 2008, operating cash flow (OCF) came in at $412M, down 23% YoY.  Excluding the auction rate securities situation ($73.3M), OCF was still down 9% from 2007.  The company registered very large cash outlays for accrued taxes and other liabilities, which is reflected in the company’s improved current ratio discussed below.
  • The balance sheet is still rock-solid, despite the announcement of yet another 8500 build.  Ensco improved their current ratio from 2.7 to 4.5, with a huge paydown in accrued liabilities.  Long-term debt was reduced 3% and shareholders’ equity increased 13% from YE 2007.  Considering that Ensco have announced two additional 8500 builds and have a share buyback in progress, the fact that these activities have been funded mostly by operations illustrates Ensco’s robust business.
  • The income statement mostly held steady.  Operating and net margins remain at recent years’ levels of 57% and 46% respectively.  The company did fall down a little on operating expenses and especially on contract drilling expense, which was up 27% YoY and 12% from Q1 2008.  While some of the company’s increased operating expense was front-loaded this year (a portion of which will be recoverable), management conceded that contract drilling expense will be 18-20% higher from 2007 levels.

All in all, a pretty solid quarter for Ensco.  Total fleet utilization rate increased to 95%, up 2 bp from 2007 levels.  Average day rates are registering double-digit increases across all regions except for the Gulf of Mexico jackup market and even there, day rates and utilization levels are increasing markedly from YE 2007 and Q1 2008.  Ensco is the sole provider of 250 foot, independent leg rigs in the GOM region and is currently operating at 100% utilization.  Management announced probable accepted tenders for 2 rigs with PEMEX as well as a possible additional rig to Venezuela.  If Congress allows drilling on the Outer Continental shelf, the rig market will come under stress to supply extra rigs.

The company announced the build of another deepwater rig, the ENSCO 8505, at a cost of $537M.  With the 2 new builds announced this year, it is no surprise that FCF is slightly negative for the 1st half of 2008.  While neither of the 2 new builds have been contracted as of yet, demand for deepwater rigs remains high.  Management talked a little about getting shipyard orders in now as Petrobras is basically cornering the deepwater rig supply with their ambitious deep-drilling plans.  I expect Ensco will have little trouble contracting these rigs well before their arrival dates in 2011 and 2012.

After last quarter’s hiccup with the ENSCO 8500, management reported on-time schedules for the new builds.  The 8500 is expected to begin work in mid Q1 2009 so any additional deepwater revenue will be pushed out into next year.  Once all 6 builds are complete, deepwater revenue is expected to comprise 30% of total revenue.

Management projects that every new jackup rig coming into the market in 2008 and 2009 will have a job so the jackup rig market looks to be holding up well despite analyst pessimism. With the Asian and European regions booked up through 2008 and into 2009 as well as the GOM jackup market showing a pick-up in demand and pricing,  Ensco certainly has good visibility into continued earnings growth for the rest of this year despite the volatility in energy prices.

2008 Guidance:

  • Earnings growth through the rest of 2008 (Q3 revenues +5% from Q2)
  • Contract drilling expense up 18-20% from 2007 (Q3 expense comparable to Q2)
  • Full year effective tax rate 18-19%
  • CapEx: $725M ($590M in new deepwater rig builds, $25M rig enhancements, $110M sustaining projects)
  • Depreciation: $196M / G&A: $53M

Performance Measurements :

  • Hit guidance — especially on contract drilling expense and shipyard days.
  • Generate top+bottom line growth of 10+% in 2008.
  • Maintain or build on the current $3.8B backlog as of YE 2007.
  • OCF run rate to revert back to 2007 levels (~40-50% of revenues or so, Q1 08: 26%) .
  • Slight tailwind in international markets as outlined by Rabun, stabilization in GOM and new entries into Iran, UAE, etc.
  • Hold the line on 8500 series roll-out:
    • 8500 pushed back to Q1 2009
    • Scheduled for 08/01/2008
      • 8501 main engine startup
      • launch of 8502 pontoons
      • keeling of 8503

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