Whether directly or indirectly, the aggressive newbuild program at Seadrill (SDRL) could benefit the most from the potential opening up of Mexico to international oil service firms. While still too early to get overly excited, Merrill Lynch suggests the potential is for Mexico to add 50 onshore rigs and 20 floaters in the next two years to pull the struggling industry out of decline.
Seadrill is a leading offshore deepwater drilling expert with a fleet of drillships, jack-up rigs and semi-submersible rigs operating in Northern Europe, U.S. Gulf of Mexico, Mexico, South America, West Africa, Middle East and Southeast Asia. The company owns positions in numerous other drilling oil services firms including 75.7% of Seadrill Partners (NYSE:SDLP) that alone is worth nearly $1 billion.
While Merrill Lynch lists Ensco (NYSE:ESV) or Noble (NYSE:NE) as its leading picks for deepwater drillers, it is hard to not argue that the aggressive newbuild program of Seadrill won't benefit the most. Whether or not Seadrill obtains the direct contracts is of no importance. The real benefit is that if Mexico absorbs 20 floaters from the market it will certainly improve the prospects of new rigs obtaining premium contracts elsewhere. Remember that the biggest risk and concern with the company remains the large debt outstanding and plans to continue growing. As long as the rigs are contracted out, the stock should see solid returns and continue paying a dividend that exceeds 8%.
Cheap PEG Ratios
The group maintains incredibly cheap PEG (price to earnings growth) ratios and the news on Mexico should only help support that the growth rates are sustainable and extremely low. Most investors likely fear the sector as cyclical and hence aren't willing to pay up for the stocks regardless of long-term contracts. The below chart shows the PEG ratios in the group of around 0.5:
Newbuilds Focused On Mexico?
Seadrill already has one rig, West Pegasus, working for PEMEX in the Gulf of Mexico so obtaining some more contracts wouldn't be a shock. As well, the company has several rigs working for BP in the US along with several newbuilds heading to BP and the West Neptune heading to LLOG in the Gulf of Mexico so it undoubtedly has experience in the region that Mexico will need.
Along those lines, the company announced back in July a plan to build four more ultra-deepwater drillships for delivery in 2015 targeting operations in areas such as the Gulf of Mexico, Brazil and West and East Africa. Combined with a new order for two premium jack-ups, the company listed the construction program as totaling 24 units, including 9 drillships, 2 harsh environment semi-submersibles and 13 high specification jack-ups.
Management sees the 39 units in the current global order book for 2014 - 2016 as insufficient to meet demand increases such as the potential in Mexico that alone could absorb a large percentage of those newbuilds. Note the new rigs are targeted at areas such as the Gulf of Mexico. With ultra deepwater production expected to surge from around 1 million barrels per today to 5 million barrels per day over the next 6 years, the industry will need to add capacity though a lot of the newbuilds will only replace an aging fleet where nearly 50% of the floater fleets are over 20 years old.
Naturally, the competitors aren't sitting still either with Ensco adding another ultra-deepwater order in June. The company currently has four active DP3 drillships working in the Gulf of Mexico, Brazil and West Africa with contracts that last until at least 2016. The company has a fifth to be delivered later this year and a total of three more on order including the June order. Clearly, Ensco is busy adding capacity including premium jackups to total eight rigs under construction, but the recent orders by Seadrill effectively match the whole order book of Ensco.
Noble lists a fleet of 79 offshore drilling rigs including three ultra-deepwater drillships and seven high-specification jackup drilling rigs currently under construction. In total the company has 69 units working now with 10 under construction. While not an overly aggressive program, the company does have significant existing work with PEMEX that could translate into further contracts for the newbuilds.
As the CEO mentioned in the new order announcement, the new drillships should ultimately increase the dividend capacity for the company. While somewhat volatile since the actual dividend is based on results, the amount continues a pattern of growth over the years. The newbuilds should only add to the potential to grow the dividend.
Seadrill remains an aggressive large cap with constant transactions within the industry that can make the company difficult to value. In the Q1 report, the company listed strategic investments in Archer Limited, Sevan Drilling and SapuraKencana are worth $1.2 billion. These values can make comparisons such as the PEG ratio listed above difficult to utilize as the significant investments get lost in the analysis. Regardless, Seadrill offers optimal growth in the sector and the ability to greatly benefit from growing demand offshore Mexico.
Investors should load up on the sector as a whole, but Seadrill is likely to benefit the most from the aggressive newbuild program that benefits from growing global demand.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SDRL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.