Ensco Remains Neutral

We have maintained our long-term Neutral recommendation on Ensco Plc (ESV - Analyst Report), one of the leading offshore contract drilling service providers. The company’s organically growing asset base, robust international markets as well as the broader recovery in jackup demand remain somewhat tempered by the continued strain on permit issuances in the U.S. Gulf of Mexico (GoM).

Having transformed from a GoM company to a relatively pure international play, U.K.-based Ensco remains well equipped to cope with the ongoing crisis in the GoM, as well as benefit from a recovery in oil-directed drilling. The international deepwater markets seem to be strong with new multi-year projects in West Africa, Brazil, South East Asia and the Mediterranean.

Management also remains optimistic about the broader recovery in jackup demand. Ensco –– with over $9 billion of contract revenue backlog excluding bonus opportunities –– remains upbeat, particularly in the Middle East, where it has recently contracted five jackups to Saudi Aramco. Notably, Ensco also communicated a positive tone on the GoM and sees increased demand for additional rigs in late 2011 and 2012. All of Ensco’s deepwater rigs in the U.S. GoM are contracted into 2013 and are presently earning at a full-day rate.

Importantly, we see substantial earnings visibility for Ensco following the merger with Pride International. The combined entity is expected to gain from recovery in the international jackup market coupled with continued strength in the deepwater market. The company again doubled its 2012 synergy expectation from the merger to $100 million from the previous $50 million. Given the increased synergies, the Pride deal looks to be over 10% accretive to Ensco, demonstrating the company's best-in-class execution.

We believe the above mentioned discussions are adequately reflected in the present valuation, leaving little room for meaningful upside from the current level. Additionally, following the GoM incident, new regulations may negatively impact Ensco considering its exposure to both deep and shallow water GoM. The continued tension on permit issuances could adversely affect the company’s operations. Hence, we expect the stock to perform in line with the broader market and peers like Rowan Companies Inc. (RDC - Analyst Report) and Precision Drilling Corporation (PDS - Snapshot Report), in the coming quarters.

Ensco holds a Zacks #3 Rank, which translates to a short-term Hold rating.