Why There Is No Reason To Panic About SeaDrill's Debt

| About: Seadrill Limited (SDRL)

One of the most common concerns that I hear from fellow investors regarding SeaDrill Ltd (NYSE:SDRL) is the company’s relatively high debt load. It is true that SeaDrill is one of the most highly levered companies in the offshore drilling industry. I am particularly worried about this and I know that I am not alone in my convictions. I will explain my reasoning in the following paragraphs. I hope that this article can also help to put this aspect of the company’s finances in a less worrisome light.

As of the most recent financial report, SeaDrill had $9,273 million in outstanding long-term debt, $435 million of which is classified as “debt owed to a related party”. This compares to total shareholders’ equity of $6,206 million. This gives the company a long-term debt to equity ratio of 1.494. The comparable figure from the preceding quarter was 1.45 so the long-term debt to equity ratio did increase slightly during the quarter. All things considered though, this is a negligible change.

In addition to the long-term debt, SeaDrill also had $987 million in current debt at the end of the most recently reported quarter. This is a very small increase from the $981 million of current debt that the company had at the end of the previous quarter. Nearly all of the increase in debt that SeaDrill had during the quarter was in the form of long-term debt. SeaDrill should have no problem handling this $987 million current debt load.

The company should experience no problem covering its close to $1 billion current debt load. SeaDrill had $824 million in unrestricted cash and cash equivalents on its balance sheet. In addition to this, the company also possessed $759 million in marketable securities. Both of these figures are as of the date of its earnings release and could certainly be subject to change, particularly the $759 million in immediately marketable securities. This is more than enough money to completely pay off the current debt even if SeaDrill were to generate further cash during the current quarter. As it is though, SeaDrill is indeed generating cash which will make it even easier to handle this current debt load.

The existence of debt generates a drag on earnings because the indebted company needs to use some of its cash flow to pay interest on its debt. If debt loads get too large, those interest payments can grow beyond the capability of the indebted company to pay. So, given the size of SeaDrill’s debt, is this a problem for the company? The answer to this question is a very definite ‘no.’

In the most recently reported quarter, SeaDrill paid $77 million in interest on its debt. While this is up substantially from the $48 million in interest payments during the prior year quarter, it still represents a very small portion of SeaDrill’s $823 million in net income. I discussed in my previous analysis of SeaDrill’s latest earnings results that this $823 million net income figure is abnormally high and was well above what the company normally earns even after accounting for growth. If this is used to determine SeaDrill’s ability to handle its debt load then the conclusion may be misleading.

This operating cash flow tells us how much money was generated from regular business operations instead of from special events or events that do not bring cash into the company (for example, SeaDrill’s $477 million gain from the deconsolidation of Seawell). This gives us a good idea of whether or not a company’s debt load is problematic.

SeaDrill’s operating cash flow in the latest reported quarter was $509 million. While this is well below the company’s quarterly net income, it is more than sufficient to cover the interest on its debt. It is also more than what is needed to cover both the interest on the debt and the company’s large dividend yield (including the special dividend).

SeaDrill’s operating profit (EBIT) for the latest reported quarter was $430 million. This gives the company an interest coverage ratio of 5.58. This tells us that SeaDrill can pay its interest five and half times over with its profits. This gives more reasons to feel secure with the company’s financial position than to worry.

SeaDrill could still cover its interest payments just fine even if its profits were cut in half. The company could not maintain its dividend if profit was to fall so severely but in a worst case scenario, SeaDrill could always cut its dividend to cover the interest on the debt.

SeaDrill has accumulated a large amount of debt over the past few years in the course of funding its rapid growth. The company has been able to turn this debt-funded rapid growth into strong cash flows. It has also allowed the company to build up a strong cash position. These things enable SeaDrill to easily support its debt load and pay out an attractive dividend to stockholders.

Disclosure: I am long SDRL.