How Transocean Ltd and Ensco PLC Continue to Defy the Critics
Oil drillers like Transocean and Ensco PLC carry cheap valuations. Both stocks trade at forward price-to-earnings multiples in the high-single to low-double digits. Oil drilling stocks more broadly aren't getting much love from the investing community. Valuations across the industry are well below the multiple of the S&P 500 Index.
Supposedly, this is because demand for oil rigs is drying up, particularly in the emerging markets, since oil majors are cutting capital expenditures due to dwindling returns on new projects. This would mean a global supply glut that will soon result in lower utilization and increased idle times throughout the industry.
However, these dire forecasts simply aren't coming to fruition. In fact, Transocean's and Ensco's most recent quarterly reports showed they are actually improving on several metrics important to an oil drilling company. That certainly throws some cold water on the bearish sentiment, which might set up these oil drilling stocks to be an ideal Foolish opportunity.
Transocean gets back on track
Transocean booked 7% revenue growth and 40% growth in operating profits in the first quarter. The company realized the dual benefits of increasing business activity and reduced costs and expenses.
This was an important show of strength for Transocean. Its first-quarter results reversed the disappointing performance in the previous quarter, which brought down the company's overall results for 2013. Transocean realized worsening utilization and fleet efficiency in the fourth quarter. Utilization stood at 75%, down eight percentage points from the third quarter. In addition, fleet efficiency dropped on a quarter-over-quarter basis as well, to 91%. The reason for this is that Transocean was forced to endure prolonged downtime on certain ultra-deep water rigs.
Fortunately, Transocean got its act together in the first quarter. Fleet revenue efficiency increased to 95% from 91%. And, fleet utilization expanded to 78%, versus 75% in the previous period. Management noted that the company experienced fewer out-of-service days in the most recent quarter, which boosted overall performance.
Going forward, Transocean management intends to keep streamlining the company to become more focused on optimizing its asset structure. This includes a fleet restructuring initiative. To accomplish this, Transocean will spin off eight of its mid-water rigs that are based in the U.K. North Sea. The separate company will be called the Caledonia Offshore Drilling Company, and demonstrates management's commitment to shed non-core assets.
Some of the bearish sentiment concerns the average ages of oil drilling fleets across the industry. This is what prompted Transocean's decision, a position that other drillers are adopting as well. Since February, Ensco has offloaded three jack-up rigs that were built in the 1980's. Ensco collected a total of $97 million in proceeds, which will help supplement future investment in its fleet.
These moves make sense, since it's wise for oil drillers to sell old rigs while they can still generate a profit. Ensco realized $19 million in gains on the sales.
For its part, Ensco has displayed resiliency to start 2014 as well. It earned $1.31 per share, down about 3% year over year. While that's certainly not impressive performance, it also doesn't signify the deterioration that its stock valuation seems to suggest. And, the current quarter is expected to be solid as well. Management is calling for about 4% revenue growth, quarter over quarter.
It doesn't appear that oil companies are cutting orders for new rigs nearly to the extent that would warrant such low earnings multiples. In its first-quarter earnings release, Ensco management reiterated that the company expects to grow earnings in future quarters because it has eight new rigs to be delivered.
Keep the long-term picture in focus
It's true that the near-term outlook for oil drillers is less than spectacular. Transocean and Ensco both face challenges from Big Oil cutting capital expenditures. This is putting pressure on day-rates and utilization. However, it's important to see past the short-term bumps in the road to understand the long-term Foolish opportunity.
The fundamentals of the oil drilling industry are sound. The world's energy needs continue to evolve, but oil still holds a place as a major energy source. Put simply, oil drilling isn't about to end anytime soon, and the compelling valuations and hefty 5%-7% dividends offered by Transocean and Ensco are too good to ignore.
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The article How Transocean Ltd and Ensco PLC Continue to Defy the Critics originally appeared on Fool.com.Bob Ciura owns shares of Ensco. The Motley Fool owns shares of Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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