Seadrill Limited (SDRL), which is currently trading at $35.7, has declined by nearly 26% from its all time of $48. The stock currently offers a generous dividend yield of 10.6% and looks attractive for long-term capital gains. This article discusses the reasons for considering Seadrill as a good buy.
For a company with $12.7 billion in debt, the first point to investigate would be the debt serviceability. For the first nine months of 2013, Seadrill had an EBITDA of $1,980 million. If this is annualized, the annual EBITDA for 2013 should be in the range of $2.6 billion. By this measure, the debt by EBITDA for 2013 comes to 4.8, which is certainly comfortable for a company with a contract backlog of $20 billion. Further, the EBITDA interest coverage ratio would be around 6.3 for 2013 considering an EBITDA of $2.6 billion and an annual interest expense of $420 million.
For the total debt outstanding, it is also important to mention that nearly 55% of the debt is due for repayment after 2016. Therefore, there will not be any significant pressure on cash flows in the near-term. A high contract backlog also makes debt refinancing relatively easy for Seadrill.
Therefore, debt serviceability and debt outstanding is not a concern for Seadrill and this is good news for equity holders as robust dividends should continue to flow. The third quarter 2013 report also sets the management expectation of EBITDA for 2016 at $4.5 billion. This means that the EBITDA should grow at an annual rate of 20% over the next three years. This is entirely likely given the fact that Seadrill has 11 drillships and semi-submersibles under construction coupled with 10 jack-up rigs to be delivered over the next five years.
On an immediate basis, Seadrill is expected to clock revenues of $6 billion in 2014 based on the order backlog and this should translate into an EBITDA of $3.1 billion for 2014. The EV/EBITDA valuation will become relatively attractive at 9.6 for 2014 from the current EV/EBITDA of 11.7.
While I talked about a strong order backlog of $20 billion for Seadrill, it is also important to consider the counterparties. I am uncertain economic environment; it is likely that contracts get cancelled in a downturn if the counterparty is not strong financially. For Seadrill, 67% of the contracts come from A and above rated entities - BP Plc (BP), Exxon (XOM), Petrobras (PZE), Total (TOT) and Statoil (STO).
When it comes to financial flexibility, another point to mention would be the investments made by Seadrill. The company currently has 12% stake in SapuraKencana, 50.11% stake in Sevan Drilling and 39.9% stake in Archer. The combined value of these holdings is close to $1.4 billion as of January 2014. In any case of eventuality for financing new vessels under construction, the value of the stake can prove to be critical.
Coming to the very important part on dividends, the distribution per share (on a quarterly basis) has increased from $0.85 in 3Q12 to $0.95 in 3Q13. A likely 20% increase in EBITDA in 2014 and an increase in operating cash flows can imply a dividend in the range of $4-$4.2 in 2014. At a current stock price of $35.7, the dividend yield can be as attractive as 11.8% for 2014.
Finally, there might be a question on why Seadrill has corrected by nearly 25% from its peak in the last 3-4 months. I believe that this concern is aptly answered by the company's comments on the industry in their third quarter report -
The fundamental outlook for the offshore drilling industry remains firm. Exploration and production companies continue to view deep and ultra-deepwater acreage as attractive areas to invest capital. Several oil companies are however encountering a period in which cash flows are challenged and budgets must be re-examined. It is typical during these periods for project commencements in all regions to slow on the margin before growth capital is deployed in the most impactful projects that will replace reserves and grow free cash flow. As a result of the pause in upstream spending we have observed a decline in the overall number of fixtures, lead times and contract duration. We also expect to see a number of sublets adding to near term available supply. Contrasting with 2012 when the market was under supplied, based on these observations it is clear that the market is adequately supplied currently and may encounter some challenges in 2014. Importantly, these challenges will be acutely felt by lower specification assets while Seadrill is positioned in the high end of asset classes where utilization is likely to remain at 100%.
I strongly believe that Seadrill has corrected as a result of some industry concerns mentioned above. But I also believe that the correction is a reaction to the general industry outlook and the company is relatively well positioned in the industry to overcome the headwinds. With the most modern floater in the industry and the second most modern jack-up fleet, Seadrill has an edge over peers. It is therefore not surprising when the company states that they will have 100% utilization for high end assets.
The conclusion is that Seadrill, with a high dividend, strong orders and a comfortable debt servicing position will continue to reap rewards for long-term investors. With a broad market correction underway, it would be a good idea to consider exposure to Seadrill at these levels or on any further correction. The current investment style should be staggered investing as broader markets can create gloom even if the stock looks attractive at an individual level.