Re-Evaluating My SeaDrill Limited Holdings

Jul.29.14 | About: Seadrill Limited (SDRL)

Summary

Back on April 22, 2014 I asserted that SDRL was one of my favorite five High Yield Stocks to accumulate.

SDRL had a generally positive earnings release and mostly appreciative price action during this time.

Over the last few days SDRL has come under price pressure and increased market skepticism.

As I look back on the five stocks I originally wrote I would be accumulating in my High-Yield portfolio, I decided to first reappraise Seadrill Limited (NYSE:SDRL). While the offshore drilling contractor is very thoroughly analyzed here and elsewhere, recent events have brought it more attention than normal.

Following just my original call on April 22, 2014 (closing price, $32.91) to today, July 28, 2014 (closing price, $36.79) would have seen a 11.79% value gain, not including the dividend distribution (ex-date June 10, pay date June 19). In my case, I reinvested the dividend. Additionally, I took the majority of my current SDRL position on May 22 at the intra-day price of 36.62, so I have missed out almost entirely on the positive value growth over this period (+2.92% with reinvested dividend). So this is a call I wish I would have been able to follow much sooner.

During this period, SDRL briefly traded in the $40 range at the end of June and beginning of July, and I had considered liquidating the newest lot holding or placing a very tight limit at or near the 10% gain line. I do not regret not having done so even now being almost back to even as it was my intention to hold SDRL at least for the rest of 2014 assuming no immediate emergency action was required, no extraordinary personal need to liquidate, and the market did not enter a confirmed correction. As such, things have progressed for SDRL very similarly to my low-side expectation -- that I would book the reinvested dividend somewhere in the +2.5% range and even sideways price action (which has been the case in the aggregate since May 22) would be okay. I am personally waiting for SDRL's newest production units to come online and begin earning profits, and while the price of oil remains elevated, demand for the drillships should continue.

Now looking out more broadly than my own internal reasoning, there have been a few recent events that have analysts and investors concerned.

1) SDRL management offered, rescinded, then re-offered a sweetened convertible bond program. On July 23, SDRL announced 84.1% of 2017 bondholders accepted the July 18 offer, falling short of the 90% necessary to force bondholders who did not voluntarily convert to convert. As Anthony Ruben pointed out, had this 90% threshold been reached, the accelerated notification and reply schedule would have resulted in "'insiders' and large holders being treated differently than small funds and 'mom and pop' investors."

2) Consideration of SDRL's debt position and relative safety of the dividend is constantly under scrutiny. Seeking Profits in fact concludes the dividend is likely unsustainable despite, or possibly contributed by, the recent moves to shore up their debt situation, and may not generate free cash flow in excess of the dividend for another five years -- meaning increased debt, or decreased dividend, or both.

3) The delivery of West Neptune should be coming soon (and scheduled to begin drilling in the Gulf of Mexico in October), and many will be carefully watching to ensure that the other 8 Ultra-Deepwater Drillships and Semi-submersibles currently under construction without existing contracts enter utilization as soon as possible. On June 2, it was announced West Jupiter had been contracted for 5 years to Total Upstream Nigeria Ltd, and I expect another announcement soon regarding a contract for West Saturn.

4) With the increasing escalation of events in the Ukraine, it is possible there could be risks to SDRL with the recently announced partnership agreement between Rosneft and North Atlantic Drilling (NYSE:NADL) (a John Fredriksen sister company to SDRL) and the possibility of Rosneft acquiring a 50% interest in SDRL. Both partnerships could be endangered or complicated by increasingly harsh sanctions regimes, or other unpredictable risks that could result from further escalation of hostilities.

If, however, you agree with the recent Barron's summation for the contrarian case for SDRL (among other industry peers) "When Haters Have Nothing Left to Hate", then it is possible to initiate or to add to a position at the current levels and hope that the headwinds prove to be not as severe as feared. Since I have fully committed to my SDRL position, I would not be looking to accumulate unless price action puts it back near the $33 range, at which price I would like to average down my holding acquisition cost. My price range for liquidation prior to my planned reappraisal would be reaching $46 before the June 2015 dividend, representing a 40% gain on my entry price and a four-year acceleration of profit on dividend reinvestment.

I have created a public portfolio at Reuters.com to keep track of the results of my High-Yield Portfolio over the course of time. I created the portfolio with $1000 of each of the above five stocks based on their 4/17/14 closing prices (KCAP 8.03, SDRL 32.75, NAT 8.67, HRZN 13.13, and FSC 9.39). You will need to have a Reuters login to see the portfolio and create your own public portfolios, but this is a free service.

Disclosure: The author is long SDRL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.