Time to Buy This Offshore Driller?

Things are looking good for offshore drilling companies. A confluence of factors has created an especially strong market for their services. Among the bigger offshore drillers, one company stands out in terms of its overall fleet quality and its favorable exposure to the highest-growth markets.

A new and high-quality fleet
Ensco (NYS: ESV) is the world's second largest offshore drilling company, with a market cap of around $13 billion. When it comes to the quality of its overall fleet, Ensco goes above and beyond its peers. Not only is its fleet the second largest in the industry, but its ultra-deepwater fleet is also the industry's newest. Its overall fleet includes nine ultra-deepwater drillships, 20 semisubmersibles, and 47 premium jack-up rigs.

A younger fleet offers a couple of crucial advantages. First, younger fleets tend to have significantly less downtime. Second, they also tend to earn higher dayrates compared with older fleets, which often have very long idle times. This is something Transocean (NYS: RIG) , the world's largest offshore driller, has learned the hard way.

Not only has the company had to shell out a ton of money to upgrade its older rigs, but it also lost a contract earlier this year on one of its older ultra-deepwater rigs because of extended downtimes. The rig, which was 13 years old, would have earned a dayrate of $630,000 had the contract continued.

By comparison, Ensco's ultra-deepwater rigs are just two years old on average, and its average deepwater rig is seven years old. This means costly upgrades can be avoided for several years, while its rigs continue to earn nice dayrates.

Expansion plans
Ensco has plans to add seven ships to its fleet over the next year and a half. Of these additions, one is a semisubmersible, three are drillships, and three are premium jack-ups. One of the drillships was recently delivered and has already been contracted out to BP (NYS: BP) for a dayrate of $522,000. As these newbuilds come under contract, they should provide significant revenue and cash-flow growth over the next few quarters.

Strong second-quarter results
Ensco's second-quarter results were quite impressive. Boosted by last year's acquisition of Pride International, the company's net income rose nearly 235%, to $341.3 million, compared with the year-ago quarter. Revenues jumped 90% from the same quarter last year, coming in at $1.07 billion. And contract drilling expenses came in at $490 million, a 41.6% rise from the year-earlier quarter. This was due largely to higher labor costs and higher rig-utilization rates.

Ensco's results were bolstered by tremendous strength in the deepwater and ultra-deepwater drilling markets. Revenues from the deepwater segment rose nearly 250% to $572 million, compared with $232 million in the year-ago quarter. Even excluding the impact of the Pride acquisition, deepwater revenues rose 71%. Revenues for the company's jack-up segment also improved by 31% from the year-ago quarter, coming in at $378 million.

Dayrates and utilization rates
Key drivers for growth in the deepwater segment were the addition of a new ultra-deepwater semisubmersible rig and dayrates earned by an older semisubmersible rig, the ENSCO 7500. The term dayrate refers to the daily cost of renting the rig incurred by the operator. The rig is currently contracted out to Brazilian state-led oil giant Petrobras (NYS: PBR) and earns a dayrate of $320,000.

However, considering that operations in Brazil tend to earn higher rates on average compared with other deepwater operations, this rate appears low. For example, SeaDrill (NYS: SDRL) earns an average dayrate of around $465,000 for a five-year contract with Pemex in the Gulf of Mexico.

With that said, Ensco would benefit tremendously from higher average dayrates. With the majority of its deepwater fleet coming off contract by the end of 2014, new customers will be bidding to use the company's rigs. And given the extremely tight supply-demand balance for deepwater and ultra-deepwater rigs, Ensco should have no problem securing higher dayrates on its newer contracts.

The company has made solid progress on raising utilization rates, which improved to 91%, up from 86% in the previous quarter. Better utilization rates improve revenues, earnings, and cash flow, so this upward trend is a welcome development. Going forward, management expects rates to improve even further.

Final thoughts
There are numerous reasons to like Ensco. Growth in offshore deepwater drilling is likely to continue for many years to come, and this should remain a key driver of the company's success going forward. Ensco's overall fleet quality is excellent, it's leveraged to several key, high-growth markets, and it boasts a very broad customer base. It also leads the industry in customer satisfaction, with several big-name repeat customers, and offers a decent dividend yield of 2.6%, or $0.38 per Class A ordinary share.

The company's average dayrate for deepwater operations is a little under $400,000, compared with a global fleet average of roughly $470,000 for drillships and around $415,000 for semisubmersibles. Going forward, if the company can secure higher dayrates on its new contracts, it should result in substantial growth in revenues, earnings, and cash flow.

As far as the attractiveness of the company's stock goes, it looks as if the market has already caught on to Ensco's promising outlook. Shares of Ensco have soared nearly 30% in just the past two months. While I would have considered Ensco significantly undervalued back in June, that no longer looks to be the case. The stock is near the highest end of its 52-week range. While it may still present a compelling buy at the current price -- given the strong outlook for deepwater drilling and Ensco's highly favorable position in that space -- more value-oriented investors may consider waiting for a price pullback.

To learn more about the strengths and weaknesses of offshore driller SeaDrill, as well as what to expect from the company going forward, be sure to check out this brand-new premium report our analysts have put together. Get started.

The article Time to Buy This Offshore Driller? originally appeared on Fool.com.

Fool contributorArjun Sreekumarowns no shares of any companies listed above. The Motley Fool owns shares of Seadrill, ENSCO, and Transocean.Motley Fool newsletter serviceshave recommended buying shares of Petroleo Brasileiro and Seadrill. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.

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