A Few Reasons Why Investors Should Avoid Seadrill

Aug.11.14 | About: Seadrill Limited (SDRL)

Summary

Seadrill has just landed a contract with ExxonMobil, but investors shouldn't read too much into this contract win due to certain factors.

Seadrill's recent results were weak, and there might be not much relief for the company going forward.

Seadrill might face trouble in Russia due to the Ukraine crisis.

Seadrill has huge debt, and its cash position is relatively weak.

Seadrill (NYSE:SDRL) gained on Friday after the company announced that it has landed a massive contract worth $497 million from ExxonMobil (NYSE:XOM). Under this two-year contract, Seadrill will provide West Saturn, its ultra-deepwater drillship to the oil major. There's no doubt that this is good news for Seadrill investors, but before jumping on to the stock, it will be wise for investors to take a closer look at the company as it doesn't look like a sound investment.

In fact, Seadrill's first-quarter results were noisy and confusing, which has put investors in a dilemma. Its revenue for the quarter declined sequentially on account of the deconsolidation of Seadrill Partners, along with downtime on the West Alpha, West Phoenix, West Pegasus, and West Polaris. The stock has declined almost 10% in 2014, and there is no respite in sight going forward.

Moreover, management gave a sequential comparison of its numbers during the quarter, rather than comparing it on a year-over-year basis. Seadrill also did not issue any guidance for the rest of the year. From all these facts, it seems that the company is trying to cover its challenging first quarter. But, the biggest question for investors is what lies ahead.

What next for Seadrill?

The company saw a sequential drop in revenue to $1.22 billion in the first quarter from $1.47 billion in the fourth quarter of last fiscal. It is a bit odd comparing these numbers on a sequential basis, and as mentioned, this might be because Seadrill is trying to hide its poor performance. Management was not pleased with the results, and anticipates better performance in the future. In fact, some of the initiatives it took during the quarter helped the company reduce its equipment downtime.

Going forward, Seadrill is counting on the various contracts that it has won, expecting them to act as growth drivers and improve its balance sheet. During the second quarter, the offshore contractor expects to take delivery of West Neptune, which will be mobilized to the Gulf of Mexico to begin its three-year contract in October. In addition, it will also take delivery of two ultra-deepwater Samsung drillships, along with a semi-submersible Sevan developer.

Positive indicators

Seadrill also has a long-term contract with a supermajor in the form of Rosneft, which will play a decisive role for it in the Russian market and Arctic regions. Its agreement with Rosneft will provide a boost for NADL (North Atlantic Drilling Limited), which is owned by Seadrill. This agreement will allow NADL to enter the land rig drilling business in Russia. Seadrill's Mexican joint venture is also on track, while the company also sees solid opportunity in West Africa, Australia, Brunei, and Saudi Arabia.

Seadrill's offshore expansion portfolio also includes a strategic partnership with SapuraKencana. Although Seadrill has reduced its position in it, but according to management, "Seadrill will continue to support SapuraKencana strategy of growing its broad offshore service portfolio and we are very pleased with our cooperation with SapuraKencana to date."

Along with its expansion plans, Seadrill has taken various initiatives to increase its dividend. Seadrill has created an additional dividend capacity fund by preserving around 20% of net proceeds from MLP dropdowns. The remaining 80% will be used for reducing its existing debt and fuel future growth.

Reasons to stay away

However, the company has a weak balance sheet, and its dividend is too high. Seadrill's cash position is weak at $2 billion, especially considering that it has huge debt of $14 billion. The company's current ratio of 0.92 indicates a weak liquidity position. Moreover, Seadrill's levered cash flow over the last twelve months is a negative $3.58 billion.

In addition, Seadrill's prospects in Russia might take a hit due to the Ukraine crisis. As reported by The Moscow Times:

"Russian companies, including oil giant Rosneft, may face challenges refinancing $112 billion in debt due to mature over the next four years, a report by Moody's Investors Service said.

Moody's said there was a very significant bank and bond debt maturity hurdle for Russian companies concentrated among Rosneft and state-controlled gas company Gazprom in 2015.

Russian companies are facing tougher conditions to refinance international loans since the West imposed sanctions on some of them over Russia's involvement in Ukraine. On top of this, the country's economy has slowed and is expected to grow just 0.5 percent this year."

Hence, Rosneft's inability to refinance its debt might force it to cut on development projects, and this might hurt Seadrill going forward.

Unimpressive valuation

Finally, Seadrill's valuation is not up to the mark either. The company has a trailing P/E of 3.4, but it a forward P/E of 10 indicates that earnings are expected to decline. Therefore, considering these factors, it will be prudent for investors to avoid Seadrill as it looks like a risky investment.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.