Seadrill Ltd. (SDRL) announced its third-quarter 2012 results on Monday, November 26. Overall, these results were fairly good despite missing analysts' expectations. The company's operating results were slightly worse than in the third quarter of 2011 but this is due to normal business fluctuations, which will be discussed later. Overall, I see nothing for investors in the company to worry about here. I will provide analysis of these results shortly but first, here are the highlights from Seadrill's third quarter:
- Seadrill generated EBITDA of $574 million in the third quarter. This represents a 6.21% decrease from the $612 million EBITDA that the company reported in the third quarter of last year.
- Seadrill had a net income of $216 million in the third quarter. This works out to $0.40 per share. It also represents a substantial increase of 272% over the $58 million that Seadrill earned in the third quarter of last year.
- Seadrill ordered another ultra-deepwater drillship. This new rig will cost the company $600 million.
- Seadrill will pay out two dividends of $0.85 each in December. These dividends are the regular dividends for both the third and fourth quarters. The company is paying the fourth-quarter dividend early so that U.S.-based investors will receive it in advance of the potential tax hikes in January.
Seadrill entered into new contracts worth a total of $2 billion during the third quarter. This has brought the company's contract backlog up to $21.3 billion as of November 23. This is a very good position for Seadrill to be in. The contract backlog essentially represents guaranteed revenue. There are a few cases where a customer will not be able to fulfill the contract but for the most part, the backlog is money that Seadrill will definitely receive going forward. Seadrill had total contract revenue of $1,056 million during the third quarter. Thus, this $21.3 billion contract backlog represents 20 quarters of revenue. Seadrill could thus operate at its present level for five years without securing another contract. This level of security should provide some comfort for investors in the company.
Seadrill's operating performance during the third quarter was somewhat disappointing. The economic utilization rate for the rigs in Seadrill's fleet were well below the levels that we have come to expect from this company, although the company's utilization was still fairly good when compared with its peers. The company's floater rigs acheived an economic utilization rate of 82% in the third quarter. However, this figure was adversely affected by two rigs, West Aquarius and West Hercules, being between assignments. These two rigs were thus in the process of being moved to their new locations during the third quarter. Excluding these rig moves, Seadrill's floater fleet achieved 88% economic utilization in the quarter. This is still well below normal for this company, which typically achieves a mid-90s economic utilization rate from its floaters. The reason for this is downtime. Seadrill experienced downtime on three ultra-deepwater rigs in the early part of this quarter. This downtime was entirely expected and I discussed it in my analysis of Seadrill's second-quarter results. The company will likely see improvements to its utilization in the fourth quarter. To date, Seadrill has seen 41 days of floater rig downtime in the fourth quarter. At the time of the second-quarter report, Seadrill had already seen 90 days of downtime in the third quarter so this represents significant improvement quarter over quarter.
Seadrill's jackup unit also posted somewhat disappointing operating results, although the division did show improvement compared with the previous quarter. The company's jack-up rig fleet achieved an economic utilization of 83% in the third quarter. This compares favorably with the 79% rate that the jack-up rig fleet achieved in the second quarter of 2012 but compares poorly with the 91% economic utilization that the jackup rig fleet achieved in the prior-year quarter. The reasons for this low economic utilization rate are largely similar to the reasons for the poor performance of the floater fleet: mobilization. Seadrill stated that rig moves took a longer period of time than expected. The West Triton, West Vigilant, West Resolute, West Callisto, and West Defender only operated for part of the third quarter due to mobilization. If the negative impact to economic utilization due to these rig moves is excluded then Seadrill's jack-up fleet achieved a much more respectable 94%. There is a good chance that Seadrill's jack-up utilization will improve substantially in the fourth quarter now that the mobilization of these rigs is complete.
The highpoint of Seadrill's operations in the third quarter was definitely the tender rig fleet. Seadrill's tender rig fleet achieved a remarkable 98% economic utilization rate in the third quarter. This compares favorably to the 97% economic utilization rate that the same fleet achieved in the second quarter. Historically, this segment of the company's fleet has performed admirably, with very little downtime. These rigs also carry longer-term contracts than the company's jackup rigs do. This means that the tender rig fleet has historically had much less mobilization-related downtime than the jack-up fleet.
Seadrill is likely to see improved operational performance in the fourth quarter. As already discussed, the floater rig fleet looks likely to see much less maintenance-related downtime in the fourth quarter compared with the third. However, the West Aquarius and West Hercules, the two floaters that were being mobilized in the third quarter, will also be out of commission during the fourth quarter. Both of these rigs are scheduled to begin on their respective assignments in January 2013 and so the rigs will start generating revenue at the time. The jackup fleet should also see much better operating performance in the fourth quarter. The only reason for the poor operational performance of the jackup rig fleet was mobilization-related downtime. Of the five jack-up rigs that were mentioned earlier, only the West Callisto was still being mobilized as of November 23. The West Callisto's contract with Total (TOT) begins in November 2012 so there is a good chance that the rig will begin operating any day now, if it has not begun already.
A low economic utilization rate is a drag on both revenue and earnings. The economic utilization rate tells us how close an offshore drilling rig, fleet, or company came to achieving its theoretical maximum revenue based on the contracts that it has. It is expressed as a percentage of the maximum potential contract revenue. Therefore, the higher this rate, the closer the company came to achieving its theoretical maximum potential revenue. This means that the company brought in more revenue and, most likely, more cash flow and profit. Additionally, drilling rigs do not earn revenue during downtime or mobilization periods. The rigs do collect a fee, known as the mobilization fee, to compensate the drilling contractor for the time and expenses incurred during the mobilization period while the rig is unable to earn revenue. However, this mobilization fee is amortized over the life of the rig contract and thus is not recognized as revenue during the mobilization period. In general, an offshore drilling rig does not collect revenue at all during periods of downtime. Since Seadrill should suffer less downtime in the fourth quarter compared with the third and have fewer rigs in mobilization periods compared with the third quarter, the company should see higher contract revenue from the floater and jack-up rig fleets going forward.
Seadrill's recent sale of its tender rig division is the wildcard here. I discussed the details of this transaction in the linked article but, in short, Seadrill is potentially selling its entire tender rig division, except for three rigs, to SapuraKencana. While this deal will cause an immediate cash infusion to Seadrill, it will also have the effect of reducing the company's net income in the short term. In the third quarter, Seadrill's tender rig division earned a net income of $84 million. This places it squarely between the jack-up rig division, which earned $47 million in the quarter, and the floater division, which earned $282 million.
In another recent article, I discussed Seadrill's creeping takeover of Asia Offshore Drilling. As of November 28, Seadrill owns 65.95% of the outstanding shares of Asia Offshore Drilling and has extended an offer to acquire all of the remaining shares for a price of NOK 28.71 per share. This tender offer expires on December 10. Asia Offshore Drilling has three jackup rigs under construction with one already under contract. Should Seadrill succeed in this acquisition then it would expand the company's presence in the market for high-specification jackups. This is a market niche that looks ever more promising with each passing day.
Seadrill's management is quite optimistic of the current market for premium jackup rigs, a category that includes every jackup in Seadrill's fleet including the three that will be acquired through the takeover of Asia Offshore Drilling. The company expects that demand for these rigs will be greater than the supply of them until at least the end of 2013. This demand is being driven primarily by new field developments in Asia and the Middle East but Seadrill also notes that customers in West Africa and Australia have also entered the market for these rigs. These regions in particular have a large number of older jackups, which oil companies are looking to replace in order to gain the improved performance and safety benefits of newer rigs. This positions Seadrill quite well. Almost 70% of jackup rigs currently in operation worldwide are at least 30 years old. Seadrill has seven benign-environment jackup rigs and one harsh-environment jackup rig under construction. Given the company's track record for safety and reliability, Seadrill has the potential to become the preferred contractor for oil companies as they seek to replace these old and outdated rigs.
Seadrill has been the most aggressive player in the ultra-deepwater market over the past few years. The company currently has nine new ultra-deepwater rigs under construction. This is more than any other offshore drilling company and it positions Seadrill quite well for growth. Seadrill notes that the market for ultra-deepwater rigs continues to show the strength that it has had for the past few quarters. I discussed this strength in a recent article. Average dayrates for a new ultra-deepwater fixture are now from $550,000 to $650,000 depending on contract duration and location, with some rigs achieving even higher dayrates. Seadrill notes that the primary sources of new demand for these rigs are the U.S. Gulf of Mexico and West Africa. Despite the demand for rigs due to Petrobras' (PBR) attempts to develop Brazil's massive pre-salt deposits, Seadrill did not believe that the area was even deserving of a mention. This is a stark change from a year ago when the entire offshore drilling industry was very optimistic of the Brazilian market. This is most likely due to the increasingly hostile political environment in that country. Seadrill clearly believes that other markets will be able to make up for the problems in Brazil. It may be correct. It is estimated that more than 50% of the oil and gas reserves in the Gulf of Mexico are located at depths of more than 5,000 ft. The development of these resources will provide one source of demand for ultra-deepwater rigs. Additionally, the West African market is rapidly growing, due in part to the massive pre-salt resources located offshore Angola. The revitalization of the North Sea is providing an additional source of demand. On November 12, Seadrill announced that it has secured a contract for the West Mira semi-submersible. The West Mira contract does not begin until after the rig leaves the shipyard in early 2015. Oil and gas companies are thus clearly willing to secure rigs well before the rig becomes available in order to meet their own development goals. This proves that the ultra-deepwater rig market remains undersupplied relative to demand. Seadrill has already secured contracts for three of its nine newbuilds and is optimistic about its ability to contract out the rest for the reasons presented here. If the company is correct about this then it should see strong growth as the ultra-deepwater rigs leave the shipyard and begin their respective contractual assignments.
Disclosure: I am long SDRL.