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The trend in spending to develop offshore drilling assets by energy companies has been extremely encouraging for companies like Seadrill (NYSE:SDRL). In the anticipation of higher capital expenditures by the oil and gas industry, the offshore drilling industry stands to benefit from the emerging trend. While there are no doubts that Seadrill is operating in an industry in which the growth prospects are promising, the company's higher debt has been a great concern.

Is Debt a Concern?

It is important to look at the debt of the company as understanding the debt will help investors understand the risks associated. In this article, I will be analyzing whether or not the debt should be a concern for investors and whether the company's operations have the ability to manage the debt burden.

  • Total Debt to Total Asset Ratio

This metric measures how much of the company's assets have been financed by debt. Currently, Seadrill's debt to assets ratio stands at 0.52, lower than 2012's 0.55. A debt to asset ratio greater than 1 indicates that company has more debts than assets, as the number is below 1 and declining, this indicates that company financial leverage is declining.

  • Total Liabilities to Total Assets

Another metric that is worth considering is the debt ratio. Companies with higher debt ratio are said to be highly levered, which could be a dangerous situation if creditors start to demand repayment of debt. Currently, the debt ratio for Seadrill stands at 0.66 lower than 2012's 0.72.

Ideally speaking, the debt ratio of 0.5 reflects the fact that the company's assets are financed through equity while a greater than 0.5 figure would reflect the fact that most of the company's assets are financed through debt. In the case of Seadrill, although the ratio is higher than the standard measure, it is comparatively lower than the previous year. As the number decreases from the previous years so does the risk to the company.

  • Interest Coverage Ratio

The ratio determines the company's ability to pay off interest expenses on outstanding debt. The lower ratio indicates the fact that the company is more burdened by debt expenses; the higher the ratio the better. The company's interest coverage ratio stands at 7.66 which is higher than 5.22 in 2012. Since the interest coverage ratio is higher than 6.3 it indicates the fact that the company is not burdened by debt expense.

  • Operating Cash Flow to Debt

This metric covers the company's ability to cover debt with its yearly cash flow from operations. The higher percentage ratio reflects the fact that the company has a heightened ability to carry its total debt and vice versa.

During the last three years, the cash flow to debt ratio has been declining. Currently it stands at 0.12, lower than 2011's 0.18. Since the ratio is below 1 the company does not have the ability to cover its total debt with its yearly cash flow from operations.

But another point worth mentioning here is that almost 55% of the company's total debt is due for repayment after 2016. Therefore, in the short term, Seadrill is not expecting any significant pressure on the cash flow. However, in the long term, the strong position of backlog ensures relatively easy debt refinancing.

Quality Income Stream Supported by Backlog

The company is all set to announce its quarterly results on February 28, 2014. It expected the EBITDA to grow by 15 percent over the last quarter and this will be reflected in higher cash flows. Similarly, the company is determined to increase its dividends. With the recent dip in the stock price, the company is offering an attractive dividend yield of 10.69%, making it an interesting income stream. Going forward, the company, due to its strong backlog position, is confident it will be able to generate higher cash flows over the next few years.

Concluding Remarks

The fundamental outlook for the offshore drilling industry remains promising. Exploration companies continue to view deep and ultra-deep water acreage as potential areas to invest capital. In such a scenario SeaDrill will emerge as the most promising company with the ability to capitalize on industrial growth. The strong position of backlog reflects the good future prospects of the company.

In addition to the anticipated growth prospects, the company is not facing any significant problem of outstanding debt. Based on the debt ratios mentioned above, it can be inferred that although debt and liabilities have increased the current position of ratios indicates that the company's growth has also been maintained to offset the impact.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

Source: Is Debt A Serious Concern For Seadrill?