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Looking at profitability is a very important step in understanding a company. Profitability is essentially why the company exists and a key component in deciding whether to invest or to remain invested in a company. There are many metrics involved in calculating profitability, but for this article, I will look at Seadrill Limited's (NYSE:SDRL) earnings and earnings growth, profit margins, profitability ratios and cash flow and future rig utilization.

Through the above-mentioned metrics, we will get an idea about the company's profitability over the past 5 years and a look at what to expect in the future.

By comparing this summary to other companies such as Diamond Offshore Drilling (NYSE:DO) and Transocean LTD (NYSE:RIG), which are in the same sector, you will be able see which has been the most profitable.

All material is sourced from Morningstar, MSN Money and Seadrill Limited's webpage.

Earnings and Earnings Growth

1. Earnings = Sales x Profit Margin

  • 2010 - $4.041 billion x 27.64% = $1.117 billion
  • 2011 - $4.214 billion x 33.25% = $1.401 billion
  • 2012 TTM - $4.322 billion x 23.16% = $1.001 billion

Seadrill's earnings have decreased from $1.117 billion in 2010 to $1.001 billion in 2012 TTM. This is a decrease of 10.38%.

2. Five-year historical look at earnings growth

  • 2008 - $(164) million,
  • 2009 - $1.261 billion,
  • 2010 - $1.117 billion, 11.41% decrease
  • 2011 - $1.401 billion, 25.43% increase
  • 2012 TTM - $1.001 billion, 28.55% decrease

In looking at Seadrill's earnings over the past five years, you can see they have ranged between $1.001 billion and $1.401 billion.

In 2008, Seadrill reported negative earnings of $164 million. This was partially due to the company's responsibility of $615.0 million to "Impairment loss on marketable securities and investments in associated companies."This responsibility is one of the reasons why the company reported negative earnings in 2008.

Over the past 4 years, the demand for offshore drilling has increased. This has resulted in positive outcomes for day rates and contract length. As these variables have continued to improve, they have proven to be very profitable for the company. In 2011, as the economy and the need for offshore drilling has been strengthening, the company reported earnings of $1.401 billion.

Profit Margins

3. Gross Profit = Total Sales - Cost of Sales

In analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin. Here are Seadrill Limited's gross profits for the past two years:

  • 2011 - $4.214 billion - $1.675 billion = $1.675 billion
  • 2012 TTM - $4.322 billion - $1.723 billion= $2.599 billion

4. Gross Profit Margin = Gross Income / Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

In reviewing Seadrill's gross margin over the past five years, we can see that the company's gross margin has been steadily increasing. The 5-year low for the gross margin was reported in 2008 with a margin of 44.06%. The 5-year high for the margin was in 2011 with a margin of 60.25%. The 2012 TTM gross profit margin of 60.13% is above the 5-year average of 55.40%.

  • 2008 - $928 million / $2.106 billion = 44.06%
  • 2009 - $1.846 billion / $3.254 billion = 56.73%
  • 2010 - $2.257 billion / $4.041 billion = 55.85%
  • 2011 - $2.539 billion / $4.214 billion = 60.25%
  • 2012 TTM - $2.599 billion / $4.322 billion = 60.13%

As the gross margin is above the 5-year average this implies that management has been more efficient in the company's manufacturing and distribution during the production process over the past 5 years.

5. Operating income = Total Sales - Operating Expenses

The amount of profit realized from the operations of a business after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses, then removes depreciation. These operating expenses are costs that are incurred from operating activities and include things such as office supplies and heat and power.

  • 2011 - $1.774 billion
  • 2012 TTM - $1.785 billion

6. Operating Margin = Operating Income / Total Sales

Operating margin is a measure of the proportion of a company's revenue that is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.

The operating margin of Seadrill Limited is calculated as total operating revenues minus vessel and rig operating expenses, reimbursable expenses, depreciation and amortization, and general and administrative expenses.

Compared to 2008, the operating margin has increased. In 2008, the company reported an operating margin of 30.77%. In 2012 TTM, the company reported an operating margin of 41.30%. Since 2009, the operating margin has remained relatively the same.

  • 2008 - $648 million / $2.106 billion = 30.77%
  • 2009 - $1.372 billion / $3.254 billion = 42.16%
  • 2010 - $1.480 billion / $4.041 billion = 36.62%
  • 2011 - $1.774 billion / $4.214 billion = 42.10%
  • 2012 TTM - $1.785 billion / $4.322 billion = 41.30%

The 2012 TTM operating margin of 41.30% is above the 5-year average of 38.59%. This implies that there has been more of a percentage of the total sales left over after paying for variable costs of production such as wages and raw materials compared to the 5-year average.

7. Net Profit Margin = Net Income / Total Sales

The net profit margin is a ratio of profitability calculated as net income divided by revenue, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.

Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage - a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.

In 2012 TTM, Seadrill's net profit margin revealed a dip compared to the past 4 years. In 2009, the company reported a net profit margin of 38.75%, while in 2012 TTM the company's net profit margin was 23.16%. The latest net profit margin of 23.16% is below the past 4 year average of 30.70%.

  • 2008 - $(164) million / $2.106 billion = -7.78%
  • 2009 - $1.261 billion / $3.254 billion = 38.75%
  • 2010 - $1.117 billion / $4.041 billion = 27.64%
  • 2011 - $1.401 billion / $4.214 billion = 33.25%
  • 2012 TTM - $1.001 billion / $4.322 billion = 23.16%

As the 2011 net profit margin of 23.16% is below the 4-year average of 30.70%, this implies that there has been an decrease in the percentage of earnings that the company is able to keep compared to the company's 4-year average.

The above listed profitability margins are revealing that the company has been showing even results when compared to 2009 but gaining strength when compared to 2008. Every listed profit margin is gaining strength except for the net profit margin. As the net profit margin is below the 4-year average, this signifies a decrease in the percentage of earnings that the company has been able to keep.

Profitability Ratios

8. ROA - Return on Assets = Net Income / Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

When comparing Seadrill's 2012 TTM ROA to its 2009 ROA, we can see that the percentage of return on assets is significantly lower. The current ROA of 5.14% is below the 2009 ROA of 9.12%.

  • 2008 - $(164) million / $12.305 billion = -1.33%
  • 2009 - $1.261 billion / $13.831 billion = 9.12%
  • 2010 - $1.117 billion / $17.497 billion = 6.38%
  • 2011 - $1.401 billion / $18.304 billion = 7.65%
  • 2012 TTM - $1.001 billion / $19.479 billion = 5.14%

As the 2012 TTM ROA of 5.14% is below the 4-year average of 7.07%, this implies that management has had less of the ability to use the company's assets to generate earnings compared to the average of the last 4 years.

9. ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2008 - $(164) million / $2.629 billion = -6.24%
  • 2009 - $1.261 billion / $4.179 billion = 30.17%
  • 2010 - $1.117 billion / $5.398 billion = 20.69%
  • 2011 - $1.401 billion / $5.977 billion = 23.44%
  • 2012 TTM - $1.001 billion / $6.117 billion = 16.36%

Much like the ROA, the ROE has also revealed a decline. When compared to the 2012 TTM ROE to the 2009's ROE, we can see that the percentage has fallen significantly. The 2009 ROE of 30.17% is much higher than the current ROE of 16.36%. As the ROE has decreased over the past four years, this reveals that there has been a decrease in how much profit has been generated compared to the amount that shareholders have invested.

Cash Flows

10. Free Cash Flow = Operating Cash Flow - Capital Expenditure

A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (NYSE:FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.

It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.

When reviewing the company's free cash flow, we can see that in all but one of the past five years, Seadrill's free cash flow has been negative. The company has used its free cash to purchase assets in the case of 2012 "primarily new buildings," and pay dividends.

  • 2008 - $401 million - $2.768 billion = $(2.367) billion
  • 2009 - $1.452 billion - $1.369 billion = $83 million
  • 2010 - $1.300 billion - $2.367 billion = $(1.067) billion
  • 2011 - $1.816 billion - $2.543 billion = $(727) billion
  • 2012 TTM - $1.776 billion - $1.901 billion = $(125) million

11. Cash Flow Margin = Cash Flow from Operating Activities / Total Sales

The higher the percentage, the more cash available from sales.

If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even as the company is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.

As Seadrill's cash flow margin is positive, it does not have to take the above measures to continue operating.

  • 2008 - $401 million / $2.106 billion = 19.06%
  • 2009 - $1.452 billion / $3.254 billion = 44.62%
  • 2010 - $1.300 billion / $4.041 billion = 32.17%
  • 2011 - $1.816 billion / $4.214 billion = 43.09%
  • 2012 TTM - $1.776 billion / $4.322 billion = 41.09%

Summary

Since 2008, the company's earnings have increased significantly. In 2008, the company reported negative earnings. But In 2009, as the demand for offshore drilling began to improve, the company reported a significant increase in earnings. As the increase in day rates and contracts have improved they have proven to be very profitable for the company. In 2011, as the economy and the need for offshore drilling strengthens, the company reported earnings of $1.401 billion.

The listed profitability margins are revealing that Seadrill has been showing even results when compared to 2009 but gaining strength when compared to 2008. Every listed profit margin is gaining strength except for the net profit margin. As the net profit margin is below the 4-year average this signifies a decrease in the percentage of earnings that the company is able to keep.

The company's ROA and ROE are reflective of the decrease in the net profit margin. When comparing to 2009, the company's ROE and ROA have fallen significantly. The 2009 ROE of 30.17% is much higher than the current ROE of 16.36%, while the 2009 ROA of 9.12% is much higher than the 2012 TTM ROA of 5.14%. As the ROA and ROE have decreased over the past four years, this reveals that there has been a decrease in how much profit has been generated compared to the amount of assets the company holds and the amount of equity that shareholders have invested.

Over the past 5 years Seadrill have posted negative cash four times. The company is generating positive cash but is using its cash to purchase assets, primarily in the form of new buildings and pay dividends. As the company is generating positive cash, this implies that the company does not have to borrow money or raise money through investors to keep operating.

Looking forward:

As stated in the company's Q3 earnings report.

"On October 19th Seadrill Partners LLC (NYSE:SDLP) started trading on the NYSE following a successful IPO at a unit price of US$22.0. The listing of SDLP is a landmark transaction for the offshore drilling industry as it is the first offshore drilling MLP in history. SDLP raised through the offering $207 million USD net of transaction fees.

Seadrill received the funds raised in the offering and 75.7 percent ownership in Seadrill Partners in return for selling ownership stakes in four offshore drilling units. Seadrill Partners owns an average of approximately 30 percent in the ultra-deepwater semipage 3 submersible rigs, West Aquarius and West Capricorn, the ultra-deepwater drillship West Capella, and the semi-tender rig West Vencedor."

Also in the deal "SDLP has the right of first refusal on acquiring any Seadrill rig with a contract length that is greater than or equal to five years. In addition, SDLP has the option to acquire the tender rigs T15 and T16. SDLP could provide an additional source of funds and lower Seadrill's cost of capital as MLP investors place a premium on cash flow stability. Based on the closing unit price of US$26.58 as of November 23, 2012 our ownership stake in SDLP represented a gross value of US$831 million."

In 2013, the rig utilization rate looks to be increasing. In 2013, the company has 13 contracts coming online. The contracts coming online are with Exxon Mobil (NYSE:XOM), Statoil (NYSE:STO), BP p.l.c (NYSE:BP), Saudi Aramco Singapore, PVEP Singapore, Premier China, Chevron (NYSE:CVX), PTTEP China and Amerada Hess Singapore. While in 2013 the company has 9 contracts ending. This boasts well for the company's earnings and revenues moving forward.

Over the next few years, analysis at Bloomberg Businessweek are predicting an increase in earnings in FY 2012 and strong growth in 2013. Analysts are estimating revenues for FY 2012 at $4.3 billion and a revenue for 2013 at $5.1 billion. They are also predicting EPS for FY 2012 at $2.67 and EPS for FY at $3.16.

To read more on Seadrill, read my article: Analyzing Seadrill's Debt And Risk and Seadrill Limited: Inside The Numbers.

Source: Seadrill Limited: Profitability Analysis