Description

I want to forewarn VIC members that this is probably one of the least sexy writeups I have done for VIC.  It doesn't offer huge gain potential as some of my past writeups have- so if that's what you're looking for, I advise you to stop reading now. But if I can interest in you in a very cheap stock with solid upside potential and likely limited downside risk, then read on....

Ensco is the world's second-largest offshore driller, with 70 rigs and six more expected to be delivered to the company by the end of next year. The company has rigs in numerous locations all around the world, including among others the North Sea, Gulf of Mexico, Africa, and Brazil.

ESV is a very cheap stock, as the chart below makes plain.

So ESV trades at just 8.63 times 2013 estimates. That is obviously an extremely low multiple, both vs the broad market and relative to its closest peers (included in the chart above). It's so cheap in fact that one might assume that ESV was a boring company with very little in the way of growth prospects. However, this is not at all the case as the company's 2014 earnings estimates currently stand at $7.83, representing projected year-over-year growth of about 16%. ESV trades at just  7.42 times next year's earnings, which puts its PEG ratio at a minuscule .46. 

The fact that ESV has managed to achieve such robust profitability even while ngas prices have plumbed multi-decade lows is very impressive in my view. To the extent that one agrees with the bullish ngas thesis set forth by VIC member Utah1009 on March 14, ESV should be extremely appealing, because a strong rebound in ngas prices is not at all baked into ESV's bargain basement valuation. ESV serves as a reasonable option play on a strong ngas rebound, while likely presenting little downside risk if it doesn't occur.

ESV's balance sheet is pristine, as it has a leverage ratio of only about 28%. This compares very favorably with the company's peers (RIG is at 48%, for example).

Yet another plus for ESV is its 2.4% dividend yield.

Ensco had negative free cash flow for several years while it was building up its offshore drilling fleet. This year, however, ESV stands to benefit greatly from those investments, as free cash flow is expected to catapult into the $1.1 billion range (which would constitute the sector's strongest free cash flow yield).   ESV now finds itself in the enviable position of being able to easily fund its dividend from free cash flow. Indeed, ESV will likely be able to increase its dividend significantly over time (Jeffries analyst Brad Handler has said that he expects the company to increase it's dividend yield to around 5% in the next four years).

ESV also now boasts the youngest fleet in the sector, with an average rig age of just 3 years (by way of comparison, the average fleet age for RIG, NE and DO is 9, 11 and 22 years, respectively).  This gives ESV's fleet a significant advantage in terms of technological sophistication and safety features, which partly explains the company's impressive $11 billion order backlog.

The deepwater drilling market is generally viewed as a relative sweet spot within the overall oil services sector, and ESV's management indicated in their last conference call that they are confident that this will remain the case for the foreseeable future, saying that they have a "a very bullish outlook" on the sector, in part because roughly 45% of all jackup rigs are more than 30 years old and facing retirement.  

The company's management team is generally well regarded, as evidenced by ESV ranking #1 in the total customer satisfaction poll conducted for EnergyPoint for each of the last three years. Another indicator of ESV's strong management is the company's emphasis on safety, which has resulted in an extremely favorable safety record. This is no small advantage for a deepwater driller, as anyone invested in RIG prior to the BP disaster can attest.

Catalyst