A standout energy stock in a battered sector

AllianceBernstein upgraded a bushel of energy sector stocks this morning. Halliburton (HAL), Talisman Energy (TLM), Anadarko Petroleum (APC) and Ensco (ESV) all went to "outperform" from "market perform," while SeaDrill (SDRL) went to "market perform" from "underperform." Analysts did downgrade Weatherford (WFT) to "market perform" from "outperform."

The one I'd like to highlight from that list is Ensco.

I understand the upgrades -- since my Jubak's Picks portfolio is already long energy with positions in Schlumberger (SLB), Statoil (STO), SeaDrill and Western Gas Partners (WES). The energy sector is cheap right now and these stocks are a good long-term investment if you think the global economy will ever pick up and lead to stronger demand for oil.

But I also understand that the timing of that turn in demand is very unclear and the sector has been pounded in the last year -- Schlumberger, for example, is down 25.5% in the last 12 months -- and could get pounded some more on fears that the economies of China and the United States are slowing. That's why I've favored energy stocks with dividends -- with the exception of Schlumberger, which yields just 1.8%, all the energy stocks in Jubak’s Picks yield more than 4%. You get paid a good yield while you wait.

On a dividend basis, Ensco is more aggressive than most of the AllianceBernstein picks since its dividend is a relatively low 3.4%. But I like the way that the company has continued to pursue its strategy even through the downturn in the sector. On June 26, Ensco announced that it would buy an additional advanced ultra-deepwater drillship from Samsung because of stronger than expected demand from oil companies for the most advanced deepwater drilling platforms.

Ensco's strategy has been to build the youngest deepwater fleet in the sector and to, as much as possible, standardize that fleet. As oil companies push into more hostile but environmentally sensitive exploration frontiers with more difficult geologies, Ensco has bet, they will be willing to pay more for the newest technologies. (Ensco's fleet averages just 10 years in age, about one-third of the average across the industry.) That has turned out to be true, with day rates for the newest deepwater drill ships rising faster than rates have been rising across the industry.

Standardizing the fleet and operations promises to reduce costs. The company bought Pride International in a deal that closed in May 2011. That acquisition gave Ensco an immediate presence in the fast-growing deepwater markets off Brazil and West Africa. And the opportunity to realize big savings by bringing Pride's operations up to Enso's standards. For example, administration costs at Pride before the deal ran at about 7% of revenue versus just 3% at Ensco. The company has recently increased its projections for savings during 2012 from the deal to $100 million from the earlier estimate of $50 million.

The stock currently trades at 12 times trailing 12-month earnings and at 8.4 times projected 2012 earnings. The stock's five-year average price-to-earnings ratio is 16. I calculate a one-year target price of $67 a share. I'd be surprised if the shares dropped much below $40, but that would be a 10% decline from today’s price just north of $44. Cautious investors might like to wait for some of the summer volatility to dissipate. Put it on your watch list.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of Ensco, Schlumberger, SeaDrill, Statoil, and Talisman Energy as of the end of March. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here.