- Dividend is not currently in danger of being cut or suspended.
- Seadrill will require more debt to finance its newbuild program.
- Seadrill has capacity to issue more debt based on its operating metrics.
- Leverage ratio needs to be closely monitored.
Seadrill (NYSE:SDRL) is one of those companies that brings up a lot of emotion on both sides. Bulls and bears constantly argue over numerous issues and each side of the debate presents information that is not always entirely correct.
I used to have a short-term trading position in SDRL leaps and having exited it several weeks ago have neither bearish or bullish agenda. This particular short article will focus on two issues: dividend sustainability and debt.
1) Dividend sustainability
Once the current bondholder deal is finished and assuming all holders will convert their bonds into shares, SDRL's annual dividend liability will increase by 93 million and amount to 1.97 billion per year. Purely from a current operating perspective, SDRL should have no problem covering its dividend as its operating cash flow for 2014 should exceed 2.5 billion. In addition, SDRL receives or may receive cash from sale of portions of its equity stakes in several companies or joint ventures (see Sapurakencana, Seamex, and Seadrill Operating LP), and finally it receives cash from NADL and/or SDLP when dropping down rigs.
Where it gets complicated is when the issue of debt repayments is being brought up. The bottom line is as long as SDRL is able to refinance its existing debt, it does not have to repay principal from its operating cash flows and these cash flows can be used for dividend payments. So far, there is no reason to believe that in the short-term SDRL will be unable to refinance its debt, therefore bears are overblowing the risk of dividend being suspended or reduced at least in the near-term.
As of March 30, 2014 SDRL had approximately 14.5 billion of total interest-bearing debt. It also had commitments to shipyards to pay 2 billion within the next twelve months for newly constructed rigs. If the premise is that SDRL will not use operating cash flows to pay for these new rigs, then it has to borrow additional money to make these payments. Obviously, there is a limit as to how much SDRL can borrow. This limit is represented by its debt covenants:
- Interest coverage ratio: to maintain an EBITDA to interest expense ratio of at least 2.5.
- Current ratio: to maintain current assets to current liabilities ratio of at least 1. Current assets are defined as book value less minimum liquidity, but including up to 20.0% of shares in listed companies owned 20.0% or more. Current liabilities are defined as book value less the current portion of long term debt.
- Equity ratio: to maintain total equity to total assets ratio of at least 30.0%. Both equity and total assets are adjusted for the difference between book and market values of drilling units.
- Leverage ratio: to maintain a ratio of net debt to EBITDA no greater than 4.5. Net debt is calculated as all interest bearing debt less cash and cash equivalents excluding minimum liquidity requirements.
The leverage ratio is where it gets interesting. EBITDA is a trailing 12-month number and includes all realized gains from the sale of rigs and/or stakes in invested companies. For example, last quarter's EBITDA for debt covenant purposes would include 624 million of operating EBITDA and 440 million gain on West Auriga. For the second quarter EBITDA will be enhanced by 165 million economic gain from the sale of Sapurakencana shares and in the third quarter there will be a gain from the sale of 28% in Seadrill Operating LP to SDLP.
EBITDA for 2014 including gains on disposals will most probably amount to 3.6 billion, thus SDRL can technically have total debt of 16 billion and still be within its debt/EBITDA covenants at the end of 2014.
There will still be 4 billion dollars in newbuild commitments left for 2015 and 2016, but that amount looks to be absorbable with new debt as nominal EBITDA will grow given SDRL's current contract backlog situation, possibility of additional dropdowns at a premium to book value and new rigs being put to work.