Strong Performance Makes Seadrill An Interesting Pick

May.29.14 | About: Seadrill Limited (SDRL)

Summary

The company has reported another impressive quarter with increased operating profit and cash flows.

The delay in the delivery of some newbuilds will give the company more time to negotiate new contracts.

Deconsolidation gain should be ignored while evaluating the performance of the company.

Seadrill (NYSE:SDRL) announced its first-quarter earnings yesterday. The market did not show much reaction to the earnings announcement, as the stock price did not see much change. There are some interesting developments happening at Seadrill; the company has changed some financial reporting measures regarding Seadrill Partners (NYSE:SDLP). Seadrill has deconsolidated the financial results of Seadrill Partners for the first quarter of the year. I will talk about the deconsolidation and its impact later on in the article, but first, I will go through the earnings reported by the company.

Revenue for the quarter stood at $1.221 billion, down from $1.469 billion reported at the end of the last quarter. The decline was mainly due to the deconsolidation of Seadrill Partners and downtime on some rigs for the whole of the quarter. However, the revenue was slightly down on a consolidated basis as well ($1.436 billion), showing that the downtime on the rigs impacted the actual revenue of the company. Operating profit, however, was up from $568 million to $890 million, mainly because of the gain on sale of West Auriga to Seadrill Partners. The operating profit was also up by $6 million to $574 million on a consolidated basis.

Furthermore, the gain on net financial and other assets was $2.239 billion, compared to a loss of $286 million. The gain was mainly due to the deconsolidation of Seadrill Partners (explained later). Seadrill also received $39 million in income from Seadrill Partners and $5 million from its other subsidiary, Archer. The total cash position of the company also improved by $168 million, and the company reported total cash and cash equivalents of $912 million. An increase of $0.02 in per share quarterly dividend was a nice surprise, as it was expected that the company will freeze the dividend for about a year. Seadrill now pays $1 in quarterly dividend. The decision to increase cash dividend can mean two things: first, the company is confident about the growth in cash flows, or it could also mean that the management wants to return the cash from the sale of SapuraKencana and/or the North Atlantic Drilling (NYSE:NADL) stake.

The next item on the agenda is the economic utilization rates - for the floaters, the utilization rates came down from 94% at the end of the fourth quarter of the last year to 91% for the first quarter of this year. The utilization rate was mainly affected by some maintenance issues - utilization rates for the jack-ups remained unchanged at 97%. Seadrill's newbuilds, West Carina and West Saturn, have been delayed by six months, and four ultra-deepwater rigs due to be delivered in the next year will also be delayed. The delay gives the company more time to negotiate contracts for these rigs. It is interesting that the management clearly identified Arctic as an attractive area for newbuilds. As I have mentioned in my previous article about NADL and Rosneft deal, the co-operation might go beyond NADL, and Seadrill may also win some contracts from the Russian major. However, at this time, it will be pure speculation as to where Seadrill will win contracts for newbuilds. Nonetheless, the opportunity in the Arctic region exists.

Finally, let's talk briefly about the debt of the company. Debt has always been a sensitive topic when it comes to Seadrill. The company has financed almost all of its newbuilds and most of its fleet with debt, and the elevated levels of debt sometimes spook the investors. Deconsolidation has also resulted in a decrease of total interest-bearing long-term debt of the company.

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Source: First-Quarter Earnings Report

Long-term debt has come down to $10.7 billion for the first quarter from $11.9 billion, and the total interest-bearing debt of the company stands at $12.45 billion, down from $13.87 billion at the end of the last quarter. As I have said in my previous articles, I do not expect the debt to come down in the short term; however, debt should not be an issue for the company, as the EBITDA and cash flows provide enough coverage for the debt service.

Let's talk about deconsolidation now; all the parent companies report consolidated financial results, meaning the financial results of the subsidiaries are incorporated in the financial statements of the parent company. If the parent company has a controlling stake in a subsidiary, then all the assets, revenue and liabilities of the subsidiary will be reported on the financial statements of the parent company. However, if the parent company does not have the controlling interest, or loses the controlling interest through the sale of its stake or some other event, the accounting treatment changes for the subsidiaries. If the parent company does not have a controlling interest (usually less than 50%, but sometimes a company can also have controlling interest with less than 50% stake. However, let's keep it simple here for the sake of understanding), then the parent company will report only the share in the income of subsidiary as "income from non-controlling interest," and in the balance sheet, the parent company will also report non-controlling stake in the subsidiary.

If a parent company loses the controlling interest in a subsidiary, then it will have to report deconsolidated financial statements. Accounting for limited partnerships is different, and the parent company is actually a general partner in the partnership. So, the general partner records income from the partnership on a deconsolidated basis. When the parent company decides to report the financial results on deconsolidated basis, the assets and liabilities of the subsidiary are revalued, which results in a gain/loss for the parent company. The parent company recognizes the gain/loss in the financial statements, and removes the assets and liabilities of the subsidiary from its own financial statements. Seadrill's debt and revenue has come down, as the company has removed Seadrill Partners' revenue and debt from its financial statements. According to the accounting principles, the assets and liabilities are measured at the fair value - the revaluation of Seadrill Partner's assets has clearly resulted in a substantial gain for Seadrill. However, as these events are one-time and non-recurring, investors should evaluate the business without the gain from deconsolidation.

Bottom Line

The bottom line here is that the company remains in good position and the EBITDA and operating profit are in line. The increase in dividend should also go a long way in alleviating fears about a dividend cut. Furthermore, the delay in the delivery of newbuilds should give the company more time to negotiate contracts. Seadrill's increased exposure to the Russian market should also allow the company to grow its EBITDA and revenues over the next few quarters. In my opinion, Seadrill is in a strong financial position and it remains a solid long-term investment.

Disclaimer: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

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.