Seadrill Ltd. (NYSE:SDRL) is a top-tier offshore drilling company which owns one of the youngest fleets in the industry. Despite some impressive recent earnings, the stock suffered a rapid degradation due, in part, by an evident slowdown in capital expenditure in the offshore drilling sector by the major oil companies.
This momentarily strategic decision to slow-down capital expenditure, coupled with an over-supply of new rigs coming into the market, is putting pressure on the rig day-rate which is estimated to go lower during 2014. SDRL went down by about 20% since the beginning of 2014.
SDRL YTD chart:
The question that many investors and shareholders are asking now is, if this trend is here to continue, and if it is really justified?
I believe the key predicament is to understand the SDRL business model which lies in a thorough analysis of the company's fleet and day-rate. It is important to evaluate what is the potential revenue loss, and compare it to what analysts have said.
BofA-Merrill Lynch, on April 13, 2014, downgraded SDRL from "buy" to "neutral" with a target price down from $46 to $36:
From the Economic daily, on April 17, 2014, said that analysts at BofA Merrill Lynch, downgraded SDRL and indicated their reasoning for the downgrade:
We downgrade Seadrill to Neutral as we are no longer confident the driller can be resilient to the downturn in offshore drilling demand. We reduce utilisation rates for some rigs this year and pull down our dayrate assumptions to US$500k for all ultra deepwater uncontracted capacity. This leads us to cut our earnings by 15% 2014-16E, leaving Seadrill the most expensive offshore driller, trading on a PE of 9.2x15E, a 33% premium. As a result of the cuts our PO falls to NOK215/US$36.
Whilst a yield of 12% looks attractive, and despite management's assurance that the dividend is safe, we question how sustainable the quarterly DPS of US$0.98 would be if offshore drilling is set for multi- year period of weakness.
Separately, analysts at Credit Suisse downgraded SDRL from "neutral" to "underperform" on April 16, 2014, with a price target of $30 down from $40.
Finally, Sanford C. Bernstein increased its price target of SDRL to $39 on March 5th, 2014.
Overall, SDRL has an average rating "HOLD" and a price target at $45 based on 23 analysts.
Seadrill complete fleet situation and analysis.
The company owns and operates a fleet of 69 offshore drilling units as of February 25, 2014, which consist of:
* The tender rig consists of two barges and one semi-tender.
Note: Some offshore drilling units are owned by North Atlantic Drilling Ltd (NAD) in which Seadrill holds 73 percent.
- Drill-ships - Ultra-deep water.
SDRL has a total of 15 drillships, but only 8 are actually used or about to be used and contracted; and 7 are still under construction either at Samsung (5) or DSME (2). The seven new drill-ships in construction are all ultra-deep water drillships with a depth of 40,000 feet.
Drillships in service:
|Drillships||Prior rate $||2014 rate $||
|1||West Navigator||620,000||602,000/621,000||01/13-09/14 & 10/14-12/14||Norway|
|8||*West Neptune||-||Mobilization under construction 2Q2014/570,000||1/14-10/14 & 10/14-10/17||USA|
* For West Neptune a mobilization fee of US$ 37.5 million will be taken to income over the contract period.
SDRL has a total of 19 semi-submersibles but only 17 are actually used/rented and 2 are still under construction either at Costco (1) or Jurong (1).
|Semi-Sub.||Prior rate $||2014 rate $||
|1||***West Alpha||479,000||532,000/547,000||01/14-07/16 & 08/16-07/17||Norway Russia|
|5||West Sirius||-||490,173/535,000||07/08-07/14 & 07/14-07/19||USA|
|8||West Aquarius||530,000||540,000/615,000||01/13-10/15 & 10/15-06/17||Canada|
|11||West Pegasus||465,000||555,000/market rate||8/13-8/14 & 8/14-8/16||Mexico|
|13||West Eclipse||435,000||450,000/455,000||01/14-01/17 options||Angola|
|16||*Sevan Louisiana||-||Transit/505,000||01/14-06/14 mobilization & 06/14-01/17||USA|
* Owned by Sevan Drilling in which Seadrill owns 50.11 percent.
** For West Leo a mobilization fee of US$18 million will be taken to income over the contract period.
*** Owned by North Atlantic Drilling Ltd, in which Seadrill owns 73 percent.
3 semi-submersibles are in construction: Sevan Developer at COSCO 3Q 2014 and West Rigel 2Q 2015 and Sevan Louisiana above.
SDRL has a total of 32 semi-submersibles but only 22 are actually used/rented and 8 are still under construction in Dalian. West Titania is scheduled to be delivered now.
|Jack-up||Old rate $||2014 rate $||
|3||West Linus||-||Mob./375,000||2/14-5/14 & 5/14-5/19||Norway|
|5||West Resolute||135,000||140,000||10/12-10/16||Kuwait-Saudi Arabia|
|7||West Couragous||134,500||Mob./155,500||4/14-7/14 & 7/14-5/21||Malaysia/Mexico|
|8||West Triton||119,500||145,000||08/12-08/15||Saudi Arabia/Kuwait|
|13||West Freedom||155,000||187,000/225,000||2/14-6/14 & 6/14-12/16||Trinidad & Tobago|
|14||West Callisto||134,900||150,000||11/12-11/15 or 11/16 option||Saudi Arabia|
|16||West Mischief||-||175,000||12/12-12/14 & 12/14-04/15||Congo|
|17||AOD I||-||180,000/205,000||05/13-05/17||Saudi Arabia|
|18||AOD II||-||180,000/205,000||07/13-06/17||Saudi Arabia|
|19||AOD III||-||180,000/205,000||10/13-10/17||Saudi Arabia|
|24||West Titania||-||Delivery on March||6 years contact||Mexico|
* West Ariel is now available since March 2014.
4. Tender Rigs.
SDRL also owns two Barges and one semi-tender. There is no tender rig in construction now.
|Tender Rig||Old rate $||2014 rate $||
Seadrill Ltd. has eight drillships, 17 semi-submersibles, 24 Jackups and three tender rigs under contract as of this year. These units are operated under SDRL 100%, under North Atlantic drilling (SDRL owns 73%) or under Sevan Drilling (SDRL owns 50.11%).
Seadrill Ltd. has actually 7 drillships, 2 semi-submersibles and 8 jack-ups in construction that are not contracted now. Here is the details and delivery schedule:
|Delivery||Q2 2014||Q3 2014||Q4 2014||Q1 2015||Q2 2015||Q3 2015||Q4 2015||Q1 2016||Q2 2016||Q3 2016|
In 2014, SDRL will receive five units (three drillships and two Semi-Submersibles), in 2015, it will receive nine units (four drillships and five jackups), and in 2016, it will receive three jackups.
*Note: Two drillships are in the process of being booked, Per Wullf CEO. During Q2 2014, the West Saturn will be delivered and on Q3 2014, the West Jupiter will also be delivered, which means that only one drillship and two semi-submersibles have not been contracted yet.
Rapid look at the last Q4 2013 earnings on February 25th, 2014.
SDRL released earnings data on February 25, 2014. The company reported 0.49 EPS for the fourth quarter 2013, with revenue of $1.47 billion for the quarter. The conference call was scheduled on the same day.
Here is what Per Wullf CEO said:
Fourth quarter EBITDA of $768 million represents nearly 16% growth rate from third quarter and a 27% growth rate year-over-year. The increase in operating results in this quarter is a result of fleet additions including the West Tellus, West Auriga, West Vela, West Tucana and AOD III entering the fleet. During the year, we took delivery of 13 rigs, this is an impressive accomplishment and we are proud to maintain our industry leading uptime of 94% while taking rigs into service.
Finally, I'm pleased to announce that we have increased our dividend by $0.03 to $0.98 per share.
It seems unbelievable that analysts were punishing SDRL for showing such strength and positive results, but they did, despite a growth rate at 27% year-over-year.
Finally, Per Wullf CEO said:
The short-term outlook for floaters is influenced by the low activity level caused by reduced growth and cut back in CapEx from the major oil companies. In this regard, 2014 and 2015 show slower growth in activity levels than earlier anticipated. As oil companies' budgets are re-allocated, the entire spending complex tends to slow down. In turn, demand for offshore drilling assets is being pushed into 2015 and 2016, but importantly this downturn is not driven by a declining oil price, the prior cycles for long downturn have been caused by deteriorating [hydrocarbon] [ph] supply and demand fundamentals.
What was important is that the contract coverage for 2014 is at 96% and 72% for 2015 (including the West Saturn and the West Jupiter), which will allow SDRL to avoid the weak contracting environment scheduled to stretch to 2015.
On the jack-ups' side, SDRL on April 2, 2013, announced that it won $319 million contracts for various jack-up units. Following this deal, SDRL has 92% of its jack-up fleet capacity contracted in 2014 and 64% for 2015. Order backlog for jack-up fleet is $4.4 billion.
Here is a table showing the contract coverage for SDRL both in drillships/semi-submersibles and Jack-ups:
* Including the West Saturn and the West Jupiter.
The main concern raised by analysts is that the un-contracted part of the contract coverage for SDRL will cause the company some possible problems to funding its 12% dividend specially in 2016. However, although it is a legitimate concern that needs to be addressed and solved by SDRL, it has a limited risk for the company due to the nature of its fleet and the duration of the slowdown. I will add that this risk is already reflected in the stock price.
Conclusion and recommendation:
SDRL balance sheet has shown again some great strength on February 25th, 2014. It will help mitigate largely any potential weakness due to a momentarily capital expenditure slowdown by the major oil companies, which is estimated to last between one to two years.
This sector uncertainty has resulted to a 20% drop in the stock price since January 2014, while dividends have been raised and represent now nearly 12% per annum. They have been confirmed again by management as "rock solid."
A slew of analysts downgrades followed the weakness despite Industry showing resilience and even better earnings. Backlog for SDRL is about $21 billion (including $4.4 billion for jack-ups), and for Transocean, Ltd. (NYSE:RIG) is almost $29 billion.
The company's financial strength can be seen in multiple areas: Impressive revenue growth, higher than the industry, 21% up year-to-year; ROE that exceeds the industry and the S&P500; gross profit margins up over 58%; good net operating cash flow from operations which increased over 100% compared to last year, etc., and is powerful enough to dwarf the risk related to a high debt level at around $13.9 billion.
According to Bloomberg, five new ultra-deepwater rig contracts were awarded the last quarter. However, if we look at the day-rates, the contracts were almost 20% higher than the previous contracts. This situation seems contradicting what analysts have said to justify their recent bearishness and downgrades for SDRL.
The pace of customer spending growth is expected to be lower in 2014 and 2015, compared with 2013. Roger Hunt, Noble's senior vice president of contracts and marketing said recently at the conference call:
"There are a total of 38 ultra-deep-water rigs around the world looking for work, up from 22 a year earlier."
However, this impact will be extremely limited for Seadrill Ltd. because the contract coverage is nearly 100% for 2014 and already approaching 70% for 2015, leaving a risk of day-rate loss to a minimum until the rebound seen in 2016 or even second part of 2015.
From a savvy investor's perspective, this situation is the perfect opportunity that can possibly happen. A strong industry segment with a long-term growth potential supported by an impressive backlog, a high crude oil price, and an enticing secure dividend; which presents a momentarily weakness amplified by a negative momentum. I have been a long shareholder for many years and always averaged up when the time was right. It is time to add more SDRL to my portfolio with a target at $50 in 2016.
Disclosure: I am long SDRL. 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.