Over the past couple of months, Seadrill Limited's (NYSE:SDRL) share price has declined just under 20% from its highs in September. There are some of the reasons for this disruption but the overall trend still remains bullish. Is this an excellent time to pick up shares in Seadrill Limited? I believe it is.
At this point in the market some of the valuation metrics look attractive for a potential investment. Currently, the stock is trading at just 8.31x earnings. This is 40.91% less than 5 year average of 11.71x earnings.
Analysts at MSN are expecting Seadrill to lead the industry with a five year growth rate of 24.90% compared to the industry average of 13.30%.
Bloomberg is expecting a significant increase in earnings over the next couple of years. The average estimate from 36 analysts is revenue to hit $6.2 billion in 2015. This represents an increase of 26.53% over the next 2 years.
This growth rate expectation leads to a PEG ratio of just 0.37 according to finviz.
So, what are some of the drivers contributing to this bullish stance?
Global Demand for Offshore Drilling
Over the next four years, it is estimated that global growth in the offshore E&P sector will increase at an 8% to 10% compound annually. With spending estimates in the range of $250 billion on the development of their offshore reserves, Brazil is leading the way. Second to Brazil in E&P spending is Norway, which is anticipating $220 billion to be spent on the development of the North Sea, Norwegian Sea, and the Barents Sea while estimates are that U.S. Gulf Of Mexico E&P spending is expected to be around $190 billion over the next four years. Just within these three regions, estimates total $760 billion in E&P spending over the next four years. From a global point of view this bodes well for Seadrill Limited.
Due to increased global energy demand aided by advanced technology, that in turn is reducing costs and improving safety, the tide has turned and it has become economical for companies to pursue deepwater reserves. As leading major E&P companies such as Exxon (NYSE:XOM), Chevron (NYSE:CVX) and Petroleo Brasileiro SA or Petrobas (NYSE:PBR) have increased their presence in deepwater regions, they have increased CAPEX spending to support these developments. Over the next five years, the offshore drilling services market is expected to grow from $73.1 billion in 2013 to $121.1 billion by 2018. This is an expected growth of $48 billion or a compounded annual growth rate of 10.6%.
To compete with competitors such as Transocean (NYSE:RIG), Ensco PLC (NYSE:ESV) and Noble Corp. (NYSE:NE), Seadrill has spent a significant amount of CAPEX on upgrading and purchasing a newer fleet. Currently, Seadrill has 27 new rigs under construction (including 11 drillships and 2 harsh environment semi-submersibles) waiting in the wings so the future looks promising for the company.
Even though Seadrill has set itself up to capitalize on the bullish deepwater market, there are some capacity concerns in the offshore drilling market.
Capacity in the Offshore Drilling Market
Even though the offshore drilling market is expected to grow significantly over the next four or five years, capacity is an issue of concern to investors. The issue of capacity is of concern to all companies in the offshore drilling industry including investors in Seadrill's competitors Ensco, Transocean and Noble Corporation .
In an article published by Barron's, they issued a statement about the capacity issue.
As the industry is expected to add 21 new rigs, or 14% in 2014 and 13 new rigs, or 7.8% in 2015, Sedita believes the new rigs are creating a "potential for short-term bubble." Sedita writes:
We believe there could be potential near-term excess capacity for ultradeepwater rigs in 2014 given a substantial number of newbuild rigs entering the market in a short span of time, as well as a bit sluggish demand in some regions (Brazil, West Africa). Long-term we believe demand is strong and the market will absorb the rigs over time. In the near-term we believe all of the ultradeepwater newbuilds will find contracts; however, dayrates will likely remain flat over the coming years and we see no rate upside. The risk to utilization and dayrates is in the lower-specification mid-water and deepwater markets. We believe over the near-term that some of these lower specification rigs could see idle time between contracts and a bit softer dayrates.
As the charts below indicate, the capacity issue has been reflected in the companies' stock prices. As you can see the sector has underperformed the S&P significantly.
As the offshore drilling market continues to expand and the market absorbs the incoming rigs, this should increase dayrates and utilization rates in the future. As these rates increase so should the companies' margins, and thus shareholder value.
Even in the face of capacity concerns, as long as oil prices remain at these levels, the deepwater market should absorb these concerns. Based on current market conditions, the deepwater market is estimated to increase at a rate of 8% to 10% compounded annually. To support the increasing demand Seadrill has focused on having one of the most modern and technologically advanced fleets in the business.
As the share price has declined by just under 20% from its highs in September, some of the company's valuation metrics are beginning to look attractive. With the stock trading at a mere 8.31x earnings and an estimated growth rate of 24.90%, these valuations support an excellent buying opportunity. Having stated this, even if the stock does not create capital appreciation in 2014, the company offers a handsome yield of 9.30% for your patience.