In reply to “Ensco’s Dividends May Not Last Forever”

Yesterday, there was an article on the Motley Fool about Ensco’s (ESV) dividends. The article titled “Ensco’s Dividends May Not Last Forever started out by talking about the benefits of owning dividend paying stocks. This got me really interested as I manage a real money portfolio on – the ‘Dividend Value Plus’ . In the portfolio, I own stocks that I believe are undervalued and dividend paying stocks are given quite a lot of importance.

Coming back to the article that then takes the specific example of Ensco International (ESV) and seems to conclude that Ensco’s dividend could be at risk as its not as well covered. So, here are my thoughts on ESV and its dividend, a stock that I own in my real money portfolio.

A bit about Ensco first.
Ensco International is leading provider of offshore contract drilling services to the
international oil and gas industry. The company has historically focused on
jackup rigs designed for relatively shallow water but has devoted the majority of
capital expenditures in recent years to build up a fleet of semisubmersible rigs
capable of deepwater operations. Its offshore rig fleet includes 38 premium jackup
rigs, 8 ultra-deepwater semisubmersible rigs (of which 3 are under construction)
and one barge rig.

In FY 2009, ESV had operating cash flow of $1.2 billion. Yahoo Finance does not break up the capex, however if you look at the 10-K filing, you will know that ESV used $240 million in maintenance capex and another $623 million in growth capex ( on the buildout of new rigs that are under construction). Even after you subtract total capex of $860 million, you are left with $340 million in Free cash flow. ( Note that some folks only subtract maintenance capex when calculating free cash flow, however lets just be conservative here.).

In 2009, $14 million was paid in dividends and $6 million spent in share repurchases.

Early this year, ESV raised the annual dividend payout from $0.1/share to $1.4/share this year. With 141 million shares outstanding that works out to about $200 million in annual dividend payout.
So, paying $200 million in dividend out of FCF of $340 million seems like quite reasonably covered to me.

I too prefer to use the ratio of free cash flow by dividend just like the author did. In the case of ESV, we have
Cash flow coverage ratio = FCF / Dividend = 340 / 200 = 1.7 ( the author had a number of -1).

The rest of the article goes into some specifics of the future capex at ESV.

Couple of side notes:
1) The more commonly used metric is the dividend payout ratio. Dividend payout ratio is the dividend per share / earnings per share. I do NOT like this metric as much as the cash flow coverage ratio above, simply because dividends are paid out from free cash flow and not earnings. Yahoo Finance reports ESV’s dividend payout ratio as 16% (which looks really great when looking from the perspective of the safety of the dividend. )

2) The Yahoo number is actually not even using the forward dividend rate of $0.35/ quarter. Its using the payment over the last 4 quarters where 35c was paid in two quarters and 2.5 cents was paid in two quarters.
So, its using 0.75 in dividends and EPS of 4.59 giving the dividend payout as 0.75/4.59 = 16%. If the forward rate of $1.4 in dividend is used with EPS of 4.59, you get 30%. ( ofcourse, even the EPS number will most likely change from the last twelve months, but atleast you are using the information you know which is the increased rate of dividends)

Coming back to ESV, if you dig into the 10-k you will see that ESV is towards the end of a $3 billion capex cycle that goes towards building 7 deep-water rigs. The last 3 rigs are under construction now. The growth capex starts to taper off in 2011 and 2012 at $320 million per year. After that the free cash flow should increase considerably as capex would be down to maintenance capex ( assuming no new rigs are built, once again we will work on facts and not speculate on future actions). All these numbers are from the 10-k

These rigs that are being built will add significant revenues and free cash flow to ESV. ( the curreny daily rate on such rigs is north of $400k / day).

Finally, the balance sheet of ESV had over $900 million in cash and only $250 million in long term debt! This works out $4.6 / share in hard cash.

Conclusion: In my view, ESV has enough means to support the dividend from the free cash flows, increases in future free cash flows and a strong net cash positive balance sheet.

Disclosure: I am LONG ESV in my real money portfolio on – Dividend Value Plus.

About Adib Motiwala

Portfolio Manager at Motiwala Capital LLC
This entry was posted in dividend investing, Stock analysis and tagged . Bookmark the permalink.

3 Responses to In reply to “Ensco’s Dividends May Not Last Forever”

  1. Ensco is a good company, I’ll give you that. Management definitely impressed me with their conservatism and overall comments about the industry. Unfortunately, you may be making a bad call here. I agree with you on the dividends being covered (don’t trust the Motley Fool with anything), but I wouldn’t own Ensco if I could own Noble.

    If you watch Ensco closely, they have been in jackups for a long time (as you commented on). Their fleet, even after these upgrades to the semi-submersibles, will be about 50% jackups & this is a cause for concern. If you look at the financial performance of jackup rigs and the contracts they command in the market today, they seem to be slowly dying. The dayrates have been decreasing and there is much higher competition than there used to be. Many different management teams have talked about this and this is why everyone is shifting their focus now closer to the deepwater market.

    Take a look at Ensco’s management team talking about the jackups- haven’t built any in at least a few years, and on top of this, sold one or two of them “above book value”, as if that were the economic reason for selling the jackups. This is hardly a good reason to be dumping jackup rigs… they can see the weakness in that part of the market as well. Although they speak about having a great jackup fleet, all their actions for growth point toward deepwater. They haven’t come out much and discussed this directly, but if you take a hard look at everything they’ve been doing, it doesn’t look good.

    Why not purchase a company with the same conservatism, the same (if not better) management, and a more deepwater-oriented company with Noble? You will also notice, when comparing the specs, that the new rigs coming to market for Ensco, Diamond, Transocean, and Noble are all pretty similar, but that Noble is spending a good deal less for better-performing assets. This can be seen on Noble’s website in one of their more recent investor presentations.

    Just something to keep in mind. You may very well be correct in Ensco’s overall financial performance & ability, but I don’t trust the jackup market moving forward.

  2. Juan Velasco says:

    Good post and very good reply too, got me concerned actually since I own Ensco, so I’ll check those comments about Noble.