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Summary

  • Seadrill beat earnings expectations but came in below revenue estimates.
  • The company is aggressively expanding its rig portfolio.
  • Management is clearly positioning the company for a long-term upturn in the industry.

Background

On August 27, 2014, Seadrill Limited (NYSE: SDRL) reported 2Q 2014 net income of $653 million ($1.24 per share) on sales of $1.22 billion compared to net income of $1.75 billion ($3.68 per share) on sales of $1.22 billion in 2Q 2013. These figures beat Estimize-reported consensus earnings estimates of $0.76 per share, but came in below revenue estimates of $1.365 billion. These amounts are based on a diluted share count of 493 million in 2Q 2014 and 492 million in 2Q 2013.

Seadrill Limited is an offshore drilling contractor for the oil and gas industry. It provides its services in offshore exploration and production wells and operates in mid, deep, and ultra-deep water environments. Its main competitors include Transocean, Ltd. (NYSE: RIG), Ensco plc (NYSE: ESV) and Noble Corporation (NYSE: NE).

Key Points

  • Maintaining dividend of $1 per share quarterly for an annual yield of about 11%
  • 96% uptime for floaters, 93% uptime for jack-ups
  • $20 billion order backlog
  • Expect to earn ~$10 million in EBITDA per day by the end of the year
  • Executed contracts for $1.5 billion in order backlog
  • Cash Flow from operations of $881 million for the 1Q and 2Q of 2014
  • Cash and Cash equivalents of $543 million

Guidance

  • Expect utilization to return to high 90s for jack-ups in 3Q

What to look for in Q3

Dividend Policy and Convertible Debt

Currently Seadrill's $1 per share quarterly dividend represents an annual yield of about 11%, substantially higher than its competitors such as Transocean Ltd. and Ensco plc which maintain dividends of 7.8% and 6%, respectively. However, Seadrill has a payout ratio of over 100% which calls into question the sustainability of it without continuous earnings growth, especially in the highly competitive and oversupplied deepwater drilling industry. The company has previously issued (and converted) convertible debt to fund it, which dilutes the share pool.

Performance of Seadrill Partners and possible sale of remaining stake

Previously, Seadrill Limited spun off Seadrill Partners LLC (NYSE: SDLP) in October of 2012. Many companies within the oil industry have been spinning off MLPs, and it will be interesting to see how the separation pays off. During the quarter, Seadrill sold 28% of its interest in Seadrill Operating LP to Seadrill Partners for $373 million, reducing its ownership in Seadrill Operating LP to 42%. Following the separation, Seadrill still maintains 31.3% ownership of Seadrill Partners LLC common units.

Construction of new rigs

The company currently has 18 rigs under construction (7 Drillships, 3 semi-submersibles and 8 Jack-ups), which represent nearly a third of its total fleet. The company's aggressive posture indicates that management is positioning Seadrill for an upturn in the industry, even as near-term pressure in the offshore industry mounts.

Quick Take

Seadrill did not have a great quarter, but was still able to maintain profitability while investing in new rigs. It also brought in some new contracts and added to its already large (~$20 billion) backlog. The entire deepwater industry has been hit extremely hard by oversupply and the competition remains fierce.

Management spent a while talking about the details of individual contracts and the amount that they would add to the company's daily earnings. Management was also very thorough in answering questions from callers - they went into a lot of detail and demonstrated that they are in control of the company and have a plan. However, I wish they provided more in guidance beyond expected utilization rates for jack-up rigs. It would have been great if they addressed the company's dividend policy in-depth. From management's discussion, they made it clear that they are acting with a long-term horizon to position the company for when the industry recovers.

Seadrill has a strong balance sheet and formidable earnings power. Nevertheless, it is clear that the company is facing near-term pressure in the deepwater markets, which has cut into its profitability and raises questions about its ability to maintain its high dividend payout. Previously, the company has funded its dividends through issuing equity and via convertible debentures, which have diluted the share pool. Management is clearly positioning the company for the long-term while trying to maintain its dividend payout, so I would not be surprised if it sold its remaining stake in Seadrill Partners and/or Seadrill Operating LP in order to fund investments in new rigs and to maintain its dividend. Management clearly has a plan, and I am excited to see how the company will perform when the industry recovers.

Conference call available on Seeking Alpha here. Exhibit 99.1 with financial information (including ownership in Seadrill Partners) available here.

Source: Breaking It Down: Seadrill Limited's 2Q 2014 Earnings Call