Seeking Alpha
Long only, deep value, growth at reasonable price
Profile| Send Message|
( followers)  

Summary

  • The fundamentals of the sector remain strong and the slowdown will not have a big impact on Seadrill.
  • Seadrill's young fleet gives it an advantage over its competitors as oil and gas companies prefer newer rigs due to the fears about accidents.
  • Majority of Seadrill's newbuilds have secured contracts for the next two years and the remaining newbuilds to be delivered are also expected to win contracts.
  • Seadrill's fleet is packed with ultra-deepwater, high-specification rigs, and demand for these rigs remain high.

The second quarter results are out for most of the companies - Seadrill (NYSE:SDRL) has also reported its results and the company has fallen slightly short of the market expectations - reported EBITDA of $641 million fell short of the consensus estimates of $665 million. Furthermore, the note from the management about the weakness in the market has again raised doubts about the future of the sector in general and Seadrill's ability to maintain its dividend in particular. It is now becoming a norm, after every quarterly earnings announcement, market starts to doubt the potential of the companies operating in the sector while the fundamentals of the sector remain unchanged. Seadrill shareholders should ignore these fears and stay put - I will again try to explain in this article why I believe Seadrill will be the last to suffer in this sector even if things turn bad.

The biggest fear in the sector is that offshore drilling will see an oversupply of rigs, which will cause the day rates to fall - also, the oil and gas companies are cutting their capital expenditures in order to return more cash to shareholders. The market for the drillers remains challenging in the short term - this is what the consensus is in the market. No one is denying this. However, we also need to consider a number of factors. First of all, we need to take a look at the already present rigs in the market and the respective age of these rigs. At the moment, over 222 jack-up rigs operating in the sector are more than 30 years old. The image below shows the number of jack-up rigs and expected deliveries over the next three years.

(click to enlarge)

Source: Seadrill Second Quarter Presentation

Over the next three years, a total of 139 jack-up rigs will be delivered which will result in a 30% increase in the total number of jack-ups operating in the sector. However, at the same time, we also need to take into account that some of the old jack-up units will be retired. The oil and gas companies currently prefer newer high-specification rigs - the litigation expenses and losses can hurt a company badly due to an accident, which has prompted the oil and gas companies to prefer newer rigs. Let's assume that after scraping some old units, total addition to the current jack-up market is between 20-25% -- this is not too bad for the market and it will not impact the day rates to a greater extent as the oil and gas companies start to increase their CAPEX again.

Moving onto the company specific factors - first of all, let's look at the situation of the current and future deliveries of rigs. About 85% of the order backlog for Seadrill comes from its floaters segment. So, this segment is extremely important to the company and the contract situation here is vital. Seadrill has contracted about 97% of its floaters for the current year while the contract coverage for floaters segment over the next two years stands at 78% and 60%, respectively. Only two floaters, West Carina [drillship] and Sevan Developer [Semi-Submersible], remain up for contract - both of these floaters will be delivered in the fourth quarter of the current year. The image below shows the contract situation in the floaters segment of the company.

(click to enlarge)

Source: Seadrill Second Quarter Presentation

Jack-ups account for about 15% of the total order backlog and 97% of the rigs has secured contracts for the current year while 73% of the rigs are contracted for 2015 and 42% for 2016. A large number [8] of jack-ups will be delivered over the next two years, which is the key reason behind lower contract wins for jack-ups in 2015-16. However, there is still a lot of time for these jack-ups to be delivered and the recent contract wins show that the company will be able to win contracts for these rigs.

Finally, the comparison with its competitors - Seadrill has an edge over its competitors when it comes to the fleet status. The company has one of the youngest, high-specification fleets, which sets it apart from its competitors.

(click to enlarge)

Source: Seadrill Second Quarter Presentation

Only 3% of Seadrill's floaters were delivered before 2000 - this is the lowest position in the sector. Ensco (NYSE:ESV) stands second behind Seadrill but its proportion [28%] is still substantially higher than Seadrill. Transocean (NYSE:RIG) stands at the worst position when it comes to free and clear floater availability as 81% of its floaters will be available till the end of 2016 while Seadrill will have only 13 floaters [38% of total floaters fleet] - the most important factor here is that 12 of these 13 floaters are ultra-deepwater rigs, and the demand for the ultra-deepwater equipment remains considerably high. This is the main reason I believe the company will be able to win contracts for these units.

The above discussion highlights that the fundamentals of the sector remain strong and the company is well positioned to grow in this sector. The only way I see Seadrill suffering in this sector is that if offshore drilling see tough regulatory environment or bans as I believe the activity in ultra-deepwater will remain high due to the higher depletion rate of onshore reserves.

Bottom Line

I have only focused on the fundamentals of the sector as well as the strength of the company as I have talked about the financials in detail in my previous articles. The competitive advantage of Seadrill will allow the company to continue its growth in EBITDA and cash flows, which should allow the company to continue paying its dividends. Seadrill shareholders should look at the strength in its portfolio and the expected recovery in the offshore segment in the medium-long term. The short-term fears should not make Seadrill shareholders sell their shares - I believe Seadrill shareholders should hold on to their positions and wait for a robust recovery in the sector.

You can subscribe for real time alerts by clicking on the button at the bottom of this article.

Source: Seadrill Shareholders Have Nothing To Worry About