Ensco Lets You Make Dividend Income Hay, (While the Deepwater Drilling Sector Struggles)

05/28/2014 5:05 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

Given the general, overall negative attitude towards deepwater drillers at the moment, investors may have to patiently wait to see true appreciation, however, that's why MoneyShow's Jim Jubak thinks this stock works best as a dividend growth play.

At my workshop on dividend stocks at the MoneyShow in Las Vegas, I argued for what I called an opportunistic dividend strategy. With interest rates so low, and dividend yields not a whole lot higher, on average, I said that it paid to target attractive dividend growth stories and then to wait until the market decided to sell them at a discount.

I think that's exactly what we're getting in shares of Ensco (ESV) now and I'm adding shares of this deepwater drilling rig company to my Dividend Income Portfolio. The stock, at $51.325 at 3:00 PM on Wednesday, May 28, paid a dividend of 5.8%. I'd put a target price of $62 on the shares, but I think you're going to have to be patient—a year at least—to see that kind of appreciation.

And that's because everyone on Wall Street hates the deepwater drillers now. Day rates have dropped, and are likely to continue dropping for a while, as oil exploration and development companies cut back on capital spending and as a steady stream of new rigs, coming out of shipyards, adds to supply.

Ensco announced earnings of $1.31 a share on April 29 for its first quarter. That was 11 cents a share above Wall Street estimates. Revenue of $1.19 billion was slightly above the consensus estimate of $1.19, but up only 3.2% year over year.

The problem, though, was that Ensco reported a big drop in utilization, with just 78% of its rigs working, due to the ending of contracts and planned downtime. That was a drop from the 86% utilization rate in the first quarter of 2013. Day rates vary by region with exploration schedules, but the trend in the Gulf of Mexico indicates the problem. Ensco has several rigs that roll off contracts in the Gulf in August and October. Industry scuttlebutt says new contracts are at day rates in the high $300,000s for Ensco's modern rigs. That's quite a step down from the $400,000s and $500,000 rates at the height of the market.

Since the April 29 earnings report, I've seen at least four downgrades of Ensco from Wall Street analysts.

The deepwater rig industry is extremely cyclical and we're seeing the downside of the cycle now. That means Ensco's share price could move lower—although it has been hanging tough near $50 or so. More likely, it means that it could be a while until shares move up.

Which is why I like this as a dividend play, where you get paid better than 5% while you wait.

Ensco has one of the most conservative balance sheets in its sector (net debt to capital is just 26%) and the current dividend payout ratio is just 61% of net income and 39% of operating cash flow. I think that means the dividend is safe at current levels and leaves room for dividend increases over the next two years, even as the industry struggles.

The shares currently trade at 8.84 times trailing 12-month earnings and at nine times projected 2014 earnings per share.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of Ensco as of the end of March. In preparation for closing the fund at the end of May, as of the end of March I had moved the fund's holdings almost totally to cash.

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