Seadrill: High Valuation Relative To Its Competitors

| About: Seadrill Limited (SDRL)

Seadrill Limited (NYSE: SDRL) is an oil and gas exploration and drilling company that appears to offer upside given its strong growth and high dividend yield. SDRL is an offshore driller with 59 units, including drillships, jack-up rigs, semisubmersible rigs, and tender rigs. SDRL operates in both shallow and deep sea conditions. SDRL has a market capitalization of $12.8 billion and closed recently at $27.53 per share with a dividend yield of 10.9 percent based on an annualized dividend of $3.00 per share. SDRL just closed at $27.53 per share which is 4.6% above its 52-week low of $26.32 and 38.9% below its 52-week high of $38.24 per share.

I previous wrote about Seadrill and commented that there were some growth concerns which raised some vitriol from commentators. It had closed at $31.81 the day after I wrote my article, but is now trading down to $27.53, a drop of 13%. In comparison, SPDR S&P 500 Trust ETF (NYSEARCA:SPY) has only dropped 7% over the same time frame. The latest drop was driven by a downgrade from RBC Capital Markets over valuation concerns.

SDRL and Competitors

Ticker Name Market Capitalization ($ Millions) Enterprise Value ($ Millions) Leverage (EV/MC)
SDRL Seadrill Limited 12,848 22,006 1.7
RIG Transocean Inc. 15,268 22,697 1.5
ESV ENSCO plc 9,319 6,144 0.7
NE Noble Corporation 7,668 10,334 1.3
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Source: Data provided by Zacks.com services.

Transocean Inc. (NYSE: RIG) - RIG has a market capitalization of $15.3 billion. RIG closed recently at $47.74 per share with a dividend yield of 6.62 percent based on an annualized dividend of $3.16. Its debt level appears to be manageable. RIG just closed at $47.74 per share which is 0% above its 52-week low of $47.74 and 79% below its 52-week high of $85.47 per share. RIG has a low valuation at 5x by Enterprise to EBITDA measures. RIG has full or partial ownership of 138 mobile offshore drilling units, including 47 high-specification floaters, 25 midwater floaters, 9 high-specification jackups, 54 standard jackups, and 3 others.

ENSCO plc (NYSE: ESV) - ESV has a market capitalization of $9.3 billion. ESV closed recently at $40.43 per share with a dividend yield of 3.46 percent. Its low debt level should not be a challenge. ESV just closed at $40.43 per share which is 0% above its 52-week low of $40.42 and 47.3% below its 52-week high of $59.57 per share. ESV has a low valuation at 6.9x by Enterprise to EBITDA measures. ESV has 76 rigs, including 7 ultra-deepwater drillships, 13 dynamically positioned semisubmersible rigs, 7 moored semisubmersible rigs, 48 jackup rigs, and 1 barge rig.

Noble Corporation (NYSE: NE) - NE has a market capitalization of $7.7 billion. NE closed recently at $29.35 per share. NE has a dividend yield of 1.8% based on a trailing twelve months dividend of $0.52. Its modest debt level appears to be manageable. NE just closed at $29.35 per share which is 6% above its 52-week low of $27.68 and 57.1% below its 52-week high of $46.12 per share. NE has a low valuation at 7.1x by Enterprise to EBITDA measures. NE has 14 semisubmersibles, 12 drillships, 45 jackups, and 2 submersibles.

SDRL appears to be overvalued relative to its competitors
The following table compares some key valuation metrics across these four companies:

Valuation Metrics

Ticker EV/EBITDA EV/OCF P/B Forward P/E
SDRL 10.7 11.9 1.8 8.4
RIG 5.0 5.0 0.7 8.1
ESV 6.9 4.8 0.6 6.9
NE 7.1 7.5 1.0 7.6
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Source: Data provided by Zacks.com services and Yahoo!Finance for the Forward P/E. One note is that the forward PE for zacks and Yahoo!Finance are quite different.

By these measures, SDRL appears to be overvalued relative to some competitors. However, a quick glance at valuation metrics is risky since it does not account for growth and risk. When looking at a multiple it is often related to the inverse of the required rate of return less the long term growth. The rate of return is the component that should reflect the risk of the investment. The Capital Asset Pricing Model can provide a required equity rate of return:

Equity Hurdle Rates

Ticker Risk Free Beta Equity Risk Premium Equity Hurdle Rate
SDRL 1.9% 2.15 6.0% 14.8%
RIG 1.9% 0.98 6.0% 7.8%
ESV 1.9% 1.38 6.0% 10.2%
NE 1.9% 1.07 6.0% 8.3%
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Source: Yahoo!Finance, Author estimate for equity risk premium

This analysis shows that SDRL appears to carry the most equity risk, this is also reinforced from the fact that it has the highest leverage among the four companies as noted earlier. The second question is how does this compare to growth rates?

Growth Rates

Ticker Zacks LT Consensus Yahoo!Finance 5 Year Forward Yahoo!Finance 5 Year Historical
SDRL 11.2% 11.2% 19.6%
RIG 10.5% 3.7% -4.6%
ESV 16.0% 18.9% -16.0%
NE 16.0% 10.9% -18.4%
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Source Yahoo!Finance, Zacks.com

So SDRL has had a strong historical performance in an absolute basis and a even better on a relative basis; however, its forward expectations are much more in line with its competitors, suggesting that it should not have a premium valuation, especially given its higher leverage and risk as noted earlier. The following table puts it together using the Zacks LT growth rate. We want as much growth relative to risk as possible so the smaller the number, the better for Rate - Growth:

Rate less Growth

Ticker Zacks LT Consensus growth Equity Hurdle Rate Rate - Growth
SDRL 11.2% 14.8% 3.7%
RIG 10.5% 7.8% -2.7%
ESV 16.0% 10.2% -5.8%
NE 16.0% 8.3% -7.7%
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Source: Author calculations

Hence in this comparison it appears that SDRL has the worst position. While a negative spread is nonsensical in the mathematical equation it indicates superior growth for risk characteristics. This suggests that SDRL should have relatively lower multiples than its competitors due to higher risk and in some measures equal or lower growth. However, the immediate challenge would be to look at historical performance and note that SDRL did significantly outperform the others.

This analysis suggests that SDRL is not a clear cut winner relative to some of its competitors. In fact, it appears to be overvalued on an absolute basis for the multiple comparison as well as when I looked more closely at risk and growth. So despite a very high dividend yield, SDRL is not a slam dunk investment opportunity. One should look at its competitors as well. In contrast, NE appears to offer the best risk and growth prospects while RIG has the lowest absolute valuation multiples.

Disclosure: I am long SPY.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.