Offshore drilling has been among the industries hardest hit by the drop in oil prices over the past six months, yet it remains one of the most profitable in oil extraction. Ensco plc proved an example of that when it reported $1.16 billion in first-quarter revenue and $1.49 per share in earnings, giving the stock a price-to-earnings ratio of just over four.
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But earnings don't tell the whole story about offshore drilling today, and that's why management's comments are so important when companies announce their quarterly numbers. Here are five things I took away from Ensco's recent conference call with analysts.
The quotes below are all from CEO Carl Trowell.
Cut costs wherever they are
[W]e believe there are opportunities for significant incremental cost savings, as we described on our last call. I'm pleased to report that we are on track to achieve a 9% reduction in unit labor costs for offshore workers, plus $27 million in annual savings from streamlining our onshore workforce beginning in the second quarter of this year.
Cost savings are going into high gear in the offshore drilling industry. Any inessential personnel or rigs are being cut, and this is just another example of how far companies are going. Profits are high today, but new contracts are almost nonexistent, so companies must be proactive.
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Trowell added that Ensco will cold stack two relatively new floater rigs in the second quarter, a practice that's grown at a rapid pace in the last few months.This is a preemptive move, but it will reduce revenue and earnings going forward.
Financial flexibility is key
We further improved our financial position by refinancing near-term debt maturities with 10- and 30-year notes that we issued during the first quarter. As a result, we now have no significant debt maturities until the second quarter of 2019.
With weakness in offshore drilling demand, financial flexibility will be key for rig owners. This quote shows just how far Ensco's management has pushed out debt maturities, and for good reason. If the downturn lasts more than a year or two, companies could have trouble rolling over debt. This should at least give the companysome breathing room over the next few years, although it doesn't guarantee survival if contracts dry up altogether.
Contracts are coming through at a crawl
Drilling demand in deepwater remains very low and there have only been a handful of new floater fixtures announced so far this year. For shallow water, average commodity price hurdles to support drilling are generally lower than deepwater. As such, we are seeing some customer activity in shallow water, although competition for these opportunities will be intense.
Demand for offshore drilling rigs has fallen off a cliff; while there are a few new contract announcements here and there, activity has slowed dramatically. The risk is that rigs coming off contract will not get new work, and that's when management must decide whether to keep a rig active, cold stack it for when the market improves, or scrap the rig altogether.
Supply concerns are starting to slow
[W]e have seen several announcements regarding floater scrapping that is taking rigs out of the system, plus cold stacking of older floaters and jackups that will likely lead to future scrapping.
The industry must match supply with demand or risk reporting massive losses in the next year or two. So, cold stacking and retirements are a positive, particularly when they're coming from competitors.
Ensco has a fairly large fleet of old rigs, so don't be surprised if it is forced to cold stack or retire more rigs throughout the year. But the fact that the industry is being proactive in cutting supply is positive for a turnaround if it ever happens.
Bright signs for the future?
The recent M&A announcement by two E&P companies highlighted that they believe deepwater will continue to be a strategic high-growth and profitable piece of their business, one that is projected to see significant future investment, particularly in Brazil, which has the largest offshore reserves of any country in the world. While the near-term focus by most market participants has been on pressures from current commodity prices, it's positive to see this endorsement and investment by some of the largest E&P companies in the deepwater sector.
Trowell was talking about Noble Energy's acquisition of Rosetta Resources for $3.9 billion. In large part, explorers are still interested in low-cost assets, and with oil now over $60 per barrel we could see more activity, particularly in shallow-water drilling.
Trowell might have been grasping at straws a bit in reading into merger activity, but any sign that companies are moving beyond just cutting back production is good.
Patience is the answer in offshore drilling
Long term, demand should pick up for offshore drilling rigs as oil prices rise and excess production worldwide wanes. But it could be years before a full recovery takes place and long-term contracts are as common as they were a year or two ago.
Trowell highlighted some of the ways Ensco is preparing for any downside while maintaining its own upside if the market does rebound. That's the right thing for him to do, but whether it will pay off for investors will take years to figure out. I'm on the bullish side, but I'm definitely not ready to go all-in for offshore drilling.
The article 5 Things Ensco plc's Management Wants You to Know originally appeared on Fool.com.
Travis Hoium has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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