SeaDrill's (SDRL) shares have been falling over the last few days due to some downgrades to the off-shore drillers and fears about the increasing rig count. Some writers are too pessimistic about the sector and predict that SeaDrill can fall as much as 50%. I am bemused by these claims - I do not see any major fundamental change in the sector which might cause such a drop in the price for the biggest and the most organized off-shore driller. In fact, I believe the falling stock price only gives an opportunity to collect more shares to the long-term investors. Let's look at some of the arguments presented.
The Company has too much Debt
The classic argument against SeaDrill is that the company has too much debt. While it is true that SeaDrill is one of the most levered companies in the sector; it will be naive to look at the debt in isolation. There area few things that should be kept in mind while looking at SeaDrill's debt: First, the company has most of its debt on low interest rates - SeaDrill has been successful in raising the debt when the interest rates have been on historical low levels. Second, during the current year, the company will have only $1.5 billion debt payable, which most likely will be refinanced. An important element to remember is that almost all of SeaDrill's debt is in the form of credit facilities, which can be renewed without much hassle if the company has a good business relationship with the lending institution, or if the company's earnings visibility is not in doubt. In case of SeaDrill, both of these conditions can be met. The company has used that debt to finance its fleet of deep-water rigs, the rigs that get premium rates. Low cost debt has allowed the company to build a portfolio of rigs that will be in high demand in the foreseeable future. For a more detailed analysis of SeaDrill's debt situation, please follow this link.
Earnings are Under Threat Due to Increased Supply of Rigs
Another argument against SeaDrill is that the rig count is increasing which will result in a fall in earnings for the company. Again this factor is being looked at in isolation. It is true that the rig count is increasing, but at the same time, demand for ultra-deep water rigs is increasing. As I mentioned in my previous article, UK government is conducting another round of license issues for drilling activities in the North Sea - this region has an extremely harsh environment and the rigs that are deployed here fetch some of the highest day rates. SeaDrill's subsidiary, North Atlantic Drilling (NADL) has very strong presence in this area. Furthermore, the demand for ultra-deep water drilling is on the rise in other regions as well.
SeaDrill's fleet is largely made up of ultra-deep water rigs, and the company has secured contracts for almost all of its current rigs and new builds. Its rigs are contracted for approximately next three years. Recently, SeaDrill deployed West Auriga in Gulf of Mexico for British Petroleum (BP) - as we know this region is one of the most attractive, and most of the major oil and gas companies are spending heavily in this region. BP plans to invest $4 billion in this region annually for the next decade. West Auriga is contracted to BP till 2020. British Petroleum is just one example how the oil and gas companies are willing to spend on off-shore drilling. I believe the demand for ultra-deep water rigs will remain high as I highlighted the issues regarding the shale oil. In the wake of depleting on-shore reserves, off-shore drilling remains the most attractive alternative. Even if the oversupply affects the day rates, I believe big players like SeaDrill will be the least affected due to the premium fleets.
The most important fact to consider here is that the company generates about $3 billion in EBITDA (earnings before interest, tax, depreciation and amortization), and its debt to EBITDA ratio is just above 3 as the company has net debt of about $10 billion. However, by 2015, SeaDrill expects its EBITDA to reach $4 billion, which I believe will happen bar a catastrophe. Transocean (RIG) and SeaDrill has debt-to-EBITDA multiple of just above 3 - however, if SeaDrill achieves its target of $4 billion in EBITDA by 2015, its multiple will come close to 2.5.
As I have mentioned in my previous articles, the company is using its subsidiaries and SeaDrill Partners (SDLP) for future growth and financing. These subsidiaries pay cash dividends and the cash flows back to SeaDrill. At the same time, the company is dropping down its assets to SeaDrill partners while maintaining the control of the partnership. The company's strong ties with oil and gas companies and its operational excellence should allow the company to negotiate better deals once the new builds hit the market. I believe the pressure on SeaDrill's stock price is unwarranted and it should regain its lost value once the fears about the oversupply go away.