Is Seadrill A Better Investment Than Transocean?

 |  Includes: RIG, SDRL
by: Winning Strategies


Drilling Industry is experiencing a temporary slowdown in making new contracts.

Saedrill has strong order backlog and has the ability to win new contracts.

Transocean is experiencing low demand for its rigs.

Seadrill looks a better investment over Transocean.

After a strong demand for drilling activities in the past few years, it is now experiencing a slow-down in making new contracts. Furthermore, with the strong competition in the market, drillers are offering competitive prices to win tenders, which are lowering their day rates. This situation occurred as a result of volatility in commodity prices for oil and gas companies. Volatility in gas prices pushed their profits and cash flows, which led them to suspend growth plans to some extent. However, most of exploration and production companies and major oil and gas companies moved their capital spending towards liquid pays, which is enhancing drilling activities.

The drilling industry continues to see deep and ultra-deepwater acreage as a strong area for growth. Along with other regions like Australia, West Africa, and South America, the Middle East remains an attractive region and a prime location of demand for high-specification jack-up rigs. Mexico and the Arctic regions also present attractive opportunities as they hold about 13 percent of the world's undiscovered oil and about 30 percent of its undiscovered gas, showing that the drilling companies have a strong outlook. The current slow-down in tendering is due to the volatility in commodity prices. Furthermore, oil companies are looking for premium drilling fleets after the Macondo incident, and their focus on increased water depth areas have considerably reduced the contractibility of older equipment.

Seadrill Limited (NYSE:SDRL) is one among those drillers that have limited risks in challenging environments due its premium class of assets. However, Transocean LTD (NYSE:RIG), a closest peer of Seadrill, has been experiencing difficulties in making new contracts due to its lower class of assets in comparison to Seadrill. Looking at the headwinds that the entire drilling industry is facing, I picked Seadrill to see how it is operating in a challenging environment. I looked at its strategy, financial situation, and future prospects to gauge its dividend sustainability. I will also compare it with peers to predict which one among them is offering a better entry point with an ability to offer sustainable returns.

Where Does Seadrill Stand?

Seadrill is an offshore drilling contractor that provides drilling and well services to the offshore industry. It has a fleet of drilling units that operates in shallow water, mid-water, and deepwater areas in benign and harsh environments. Like its other group members, it is investing to enhance its portfolio. Seadrill is one of the best drillers among its competitors as it owns the highest percentage of assets in the premium classes. One hundred percent of its jack-up fleet is high specification, and ninety-four percent of its floater fleet is sixth generation ultra-deepwater. The company plans to keep this high exposure to the premium asset classes intact through capital investments and strategic M&A.

In the past year alone, it received a delivery of 13 new rigs, which are instantly contracted for long-term. In the first quarter of this year, it received a delivery of one high-specification jack-up unit, the West Titania, and one harsh environment high-specification jack-up unit, the West Linus, which already started operations for ConocoPhillps for five years. In the second quarter of this year, Seadrill will take a delivery of West Neptune, which is already contracted for three years at the Gulf of Mexico. The company is likely to take a delivery of a semi-submersible Sevan developer and two ultra-deepwater Samsung drillships. In total, the company is likely to receive a delivery of 19 new builds in the coming quarters.

With the investments on its fleet portfolio, it is getting new long-term contracts along with an extension on existing contracts. Its existing contracts are extended with Exxon Mobil in Malaysia, Total SA, an 18-month contract extension for the West Aquarius, and a contract extension for the West Capella. Moreover, the company made a contract for five potential jack-ups with Pemex that will start in the first half of this year. This contract is expected to bring $1.8 billion in revenue. The company has been able to make several other contracts for its premium jack-up rigs. Overall, the company's contract backlog stands at $18.8 billion and $13.3 billion apart from Seadrill Partners.

In the most recent quarter, the company has suffered with the downtime on the West Pegasus, West Alpha, and West Polaris, but the company still posted higher EBITDA of $788 million, which is an increase of 3% over the fourth quarter and a 21% increase on a year-after-year basis led by a full quarter operations of new builds. However, its operating cash flows are not providing enough to cover its capital requirements; thus, it has to depend on external sources to finance its new build assets. Its liquidity situation is strong with the diversified funding sources. With the strong backlog and strategy to create a premium portfolio of assets, financial institutions lend huge amounts of money to Seadrill on easy terms. Furthermore, with the deconsolidation of Seadrill partners, its financial situation improved. Its total interest bearing debt reduced to $12.4 billion from $13.8 billion.

Where Does The Other Player Stand?

Transocean has been experiencing difficulties is winning new contracts due its older fleet portfolio in comparison to its closest peer, Seadrill. Its order backlog has been coming down over the past two quarters, and its uncommitted days are increasing. However, the company has been looking to add premium high-specification rigs to its portfolio. In the last year, it has added three newly-built high-specification jack-ups in service. Its high-specification rigs, the Asgard and Invictus, are expected to commence operations in mid 2014, and it has five other high-specification floaters under construction. It has also announced the creation of a new company comprised of eight of its U.K. North Sea Midwater Floaters, which will remove excessive burden from the company. With the addition of new-build assets, Transocean is expecting to generate higher earnings this year compared to the past year. However, its cash generating potential is not very strong; in the recent quarter, its capital expenditure exceeded operating cash flows due to the updating of the fleet portfolio. Furthermore, Transocean recently increased quarterly dividends to $0.75/share. The company will pay $1.1 billion in annual dividends with the recent increase. Transocean looks confident as it will generate better profit this year with the recent rigs addition and its upcoming rigs' potential.

In Conclusion



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Both companies are trading at attractive multiples, but both companies fail to enhance the investor's confidence as their stocks have been on sell-off for the past five months. Year-to-date, RIG lost 15%, and SDRL lost 5.56% of value. Nonetheless, I believe this sell-off offers an attractive opportunity to initiate a position in these companies.

Seadrill has significantly invested on its fleet portfolio; thus, the company is in a better position to win contracts. Furthermore, it has large order backlog, which illustrates that it will keep generating big profits this year. In addition, it has recently made attractive contracts along with extensions on existing contracts, which will allow it to keep its momentum. On top of that, it possesses the highest five-year revenue CAGR of 23 percent compared with the industry average of only 10 percent.

On the other hand, Transocean is slow at enhancing its fleet portfolio, which created difficulties in securing new contracts. Going forward, its new build floaters will provide substantial growth to earnings. However, I prefer Seadrill over Transocean because Seadrill has a premium class of assets, strong backlog, high dividend yield, and a much better liquidity position.

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.