Ensco (IL/A):Raising EPS estimates, fair value to $48 Goldman-Sachs February 23, 2005
Day rates in the global jackup drilling rig market continue rising faster than consensus estimates assume, as demand is outstripping supply. With visibility on incremental demand in most regions, only modest newbuild activity (~18 rigs or <5% of current supply) w/ most deliveries beyond 2006, we believe pricing momentum is likely to continue.
We are boosting our 2005-06 EPS estimates for ESV to $1.48/ $2.30 from $1.35/ $1.90 + our fair value estimate to $48 (11.5x 2006 EV/ EBITDA) from $42. We expect similar consensus estimate increases for other drillers. After under- performing the OSX by 1500 bps in 2004, ESV has outperformed by 1200 bps in 2005. Although there is still room for outperformance, relative gains are likely to be more modest + we maintain our IL/A rating on ESV and maintain Outperform ratings on DO, RIG, BHI, SLB + SII.
VALUATION STILL REASONABLE RELATIVE TO PEERS AND PRIOR HIGHS. At yesterday's close of $39.29, ESV was trading at 12.5x/ 9.2x EV/ EBITDA on our new 2005-06 estimates vs a historical average of about 10x and a high of about 15x. Relative to its peers, ESV is at about a 6% discount, which is in line with history. On EV/ Replacement Value, ESV is trading at 111% (using historical steel prices, which are half current levels) vs the peer group average of 90%. However, ESV has historically peaked at a higher EV/ Replacement Value ratio than its peer group (140-155%) and has 25% upside to 2001 peak EV/ replacement value levels - in line with the group - and 39% upside to the 1997 peak vs +33% for the group.
PROJECTED EPS APPROACHING PRIOR PEAK PROJECTIONS, YET RETURNS STILL VERY DEPRESSED When ESV shares peaked around $45 in 4Q1997 and $44 in 1Q2001, the 2-yr forward consensus CFPS estimate was about $3.30, or slightly below our 2006 estimate of $3.43. ESV's ROCE was 21% in 1997 and 12% in 2001, with capital employed nearly doubling between 1997 + 2005 as ESV has upgraded its fleet, acquired and built new rigs. Actual EPS peaked in 1998 at $1.74 as the confluence of the Asian economic downturn and increased OPEC production precipitated a dramatic decline in oil prices that resulted in $3.00 EPS projections for 1999 never being realized. In 2001, EPS peaked at $1.45 before the US recession prompted a collapse in US natural gas prices. Our 2006 EPS estimate implies an 11.6% ROCE - still well below prior highs and roughly 300 basis points above ESV's cost of capital. Assuming the commodity macro holds up - a big "if" given historical oil price volatility - we believe ESV can earn over $3.00 in 2007, which would approach our estimate of theoretical "peak" EPS assuming historical (i.e. 1996-2001) steel prices. Theoretical peak EPS power assuming current steel prices would be over $4.00. In other words, the doubling of steel prices since the last newbuild cycle has increased the cost of new construction, and, therefore, the peak day rates needed to justify historical 10-15% project returns and theoretical peak EPS. Theoretical peak assumes all rigs are working at day rates that justify new construction.
4Q2004 EPS OF $0.26 AHEAD OF GS + CONSENSUS ESTIMATE OF $0.22 DESPITE HIGHER TAX RATE ESV reported 4Q2004 revenue 4% above our estimate due mainly to stronger jackup rig day rates outside the US Gulf of Mexico. EBITDA was 10% above our estimate as operating costs were lower than expected. ESV was the first driller not to report higher than expected operating costs in 4Q2004 and 2005 guidance indicates costs are expected flat on a per rig basis - also a first for ESV in its peer group. The comparison of actual results vs our estimate can be found in the exhibit below.
GLOBAL JACKUP MARKET IS SHORT OF CAPACITY + DAY RATES ARE RISING FASTER THAN EXPECTED The global jackup market is at effective capacity in all markets and day rates are rising rapidly. Our new estimates assume jackup rates are up about 30% in 2005 and 15% in 2006 versus previous assumptions of +20% and +10%. Details of new and old estimates may be found in the exhibit below. Our 2006 day rate assumptions are roughly 90% of levels needed to justify new construction on historical steel prices and 80% of levels needed to justify new construction (15% IRR) on current steel prices. About 30% of our rig rate assumptions in 2006 would be at or above historical steel price replacement cost levels.
JACKUP MARKET IN NEED OF INCREMENTAL CAPACITY There are currently 14-18 jackups being built - most with delivery dates beyond 2006 - which is less than 5% of total jackup supply today. Meanwhile, there appears to be significant incremental demand in many markets before the end of 2006. Todco sees potential to return all 8 of its idle jackups to service in the US Gulf of Mexico by the end of 2006. Other industry sources indicate potential incremental demand in Africa (as many as 3 in 2005), Middle East (Aramco may need 3 in 2005 and as many as 5 in 2006 and Qatar may need 1 in 2005 and 3 in 2006), Latin America (1 Venezuela + 1 Brazil in 2005 and multiple in Mexico in 2006) and Southeast Asia (multiple in Malaysia/ Indonesia and 1 in Australia). Bottom line, we are not concerned about the current level of newbuilding through 2006 under the GS commodity price forecast of $40 oil and $5.75-6.00 US natural gas and the outlook for jackup demand.
I, Terry Darling, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
