Ensign Energy Services: A Dividend Yield Trap

The bird-in-hand theory states that investors prefer the certainty of dividend payments as opposed share price appreciation. They like the feeling of actually getting a cash deposit in their account rather than risking a company investing that same cash poorly. It makes sense in certain ways, but can a company paying a high dividend be a sign of bad management? Today, we’re going to take a look at Ensign Energy Services and its S&P/TSX Composite Index leading dividend yield of 15.74%.

Background

Ensign Energy Services offers offshore oil drilling services to the North American market. It was in the news about a year ago for its hostile takeover of Trinidad Drilling for a total consideration of around $920 million in cash and debt. They are currently trading at $3.05 per share and pay have been consistently paying a dividend of about $0.12 per share, per quarter since the end of 2013 when they were trading at over $16 per share. Without knowing much more, I suspect management may be stubbornly trying to maintain its dividend in order to keep existing shareholders happy. But let’s do a more objective analysis of the company to see what’s going on.

Questions Needing Answers

The primary question we need answered is if Ensign’s management team is irrationally maintaining its dividend at the expense of doing things such as paying down debt or growing the company. Secondary questions include how long they are able to maintain the dividend and how investors might react at the announcement of a dividend cut or suspension. Finally, we should examine Ensign’s competitors to see which dividend policies they have changed since the collapse of oil prices in mid-2014.

Financial Statement Analysis

To begin, I wanted to know the financial strength of the company, and I did this by calculating four key ratios: the current ratio, the quick ratio, the financial leverage ratio and the total debt-to-equity ratio. I also compared them to the other companies in their industry, with the results being summarized in the table below:

Precision Drilling trades on Canadian Exchanges while Nabors Industries, Transocean and Noble trade on U.S. Exchanges.

With Precision Drilling being its only direct Canadian competitor, Ensign Energy has very similar financial strength ratios. They also are favourable to Nabors Industries in almost all respect, while Transocean appears to be in a better financial position with better Current, Quick and Debt/Equity ratios. However, there doesn’t appear to be an immediate cause for concern, at least not compared to its competitors.

Next, I performed a ten-year cash flow analysis for Ensign Energy Services. I chose a 10-year period because I wanted to get a sense of the cash flows the company was having during the time when oil prices were high and operations were very profitable. I also wanted to see how they responded when oil prices crashed about 5 years ago. While oil prices have not recovered substantially enough, as an investor I would expect management teams to be focused on improving debt-equity structures and using cash flow from operations to fund investing activities rather than borrowing on the hopes of a price recovery. After transferring dividend payments from financing activities to investing activities, below are the results, normalized on a per share basis:

Free Cash Flow (FCF) equals Cash Flow From Operating Activities (CFO) plus Cash Flow From Investing Activities (CFI). Other investing activities, not just capital expenditures, are included in CFI.

As you can see from the chart above, their cash flow situation is not a positive one. They ended 2018 with their worst CFO in the ten years analyzed, are investing above their 10-year average and are financing at their highest levels as well. A similar story plays out on their balance sheet with their total non-current liabilities (primarily long-term debt) ballooning to $1.5 billion due to the takeover of Trinidad Drilling. Since then, it has only gotten worse, with non-current liabilities totaling $1.87 billion to end the June quarter. One can’t help but think the $0.48 per share in dividends could be used better elsewhere.

From looking at the collapse in stock prices of Ensign’s competitors, the company’s problems aren’t unique. Offshore drilling is just not profitable at current oil prices. However, what sets Ensign apart is its reluctance to reduce or suspend its dividend even in the face of mounting debt and weak oil demand forecasts.

As you can see from the dividend yield table below, Precision Drilling, Transocean and Noble Corporation have all suspended their dividend entirely, while Nabors Industries is only yielding 1.4% on average for 2019 on a dividend cut from $0.24 per share to just $0.04. Ensign’s average dividend yield in 2019 remains high at 10.53%, while its current yield of 15.74% is merely reflective of the continuing drop in share price.

While there is no telling where oil prices will go, they are certainly betting heavily on a price recovery. However, I suspect that an impending dividend suspension is on its way and will provide for share price bounce. This may be attractive for the short-term investor, but if management’s actions to date are any indicator, this company does not have a place in my long-term portfolio.

What do you think of Ensign Energy Services’ prospects? Do you think it’s a dividend yield trap or is this a chance to buy a good company when it’s cheap? Let us know in the comments below!