SeaDrill: Q3 Results Continue To Impress, Still Likely To Beat Estimates

| About: Seadrill Limited (SDRL)

SeaDrill Ltd (NYSE:SDRL) announced their third quarter earnings results on November 30. Overall, there is much good to say about the company’s performance. Here are some of the highlights from the third quarter:

  • Revenues for the quarter were $1,029 million. This is an increase of $34 million from the preceding quarter.
  • The company had third quarter EBITDA of $612 million.
  • SeaDrill had a $23 million gain on sale from the divestment of the West Juno jack-up rig.
  • SeaDrill increased its ownership stake in Archer Limited to 39.9%.
  • Operating profit for the quarter was $480 million. This is an increase of $50 million from the preceding quarter.
  • The company added $2.5 billion to its revenue backlog. This brings the total revenue backlog to a record $13.5 billion.
  • SeaDrill slightly increased its dividend to $0.76 per quarter. Previously, the quarterly dividend was $0.70 plus an additional $0.05 special dividend per share. This additional $0.05 per share is now part of the long-term regular dividend and will continue beyond the one-year planned timeframe.
  • SeaDrill’s quarterly net income was $58 million. This gives the company a quarterly EPS of $0.07.

SeaDrill looks poised to continue to grow their earnings going forward as more rigs are completed and begin operating. The company’s long-term ambition remains to grow annual EBITDA to $3 billion. This is a realistic goal and can be achieved in two to three years based on the fundamentals of the offshore drilling market and SeaDrill’s current newbuild orders. In order to reach an annual EBITDA of $3 billion, SeaDrill would need to achieve an average quarterly EBITDA of $750 million. This would be an increase of 22.5% over current levels. Given the company’s historical record, dividend increases will likely accompany the growth in earnings.

The company’s fleet was more effectively utilized in the third quarter than it was in the second. The economical utilization rate for the company’s tender rigs during the third quarter was 94% versus 88% in the preceding quarter. The economical utilization rate for the company’s jack-up rigs was 91% during the third quarter versus 89% in the second. The economical utilization rate for the company’s floater rigs remained inline with the preceding quarter at 97%. This is an excellent sign as it indicates that SeaDrill is utilizing their fleet to a fuller potential. The company does not collect dayrate when rigs are not being utilized so their higher these numbers, the closer the company is to achieving its maximum potential revenues out of its existing fleet.

The market for ultra-deepwater rigs has been showing signs of tightening recently. This is causing dayrates to begin to inch up as evidenced by ExxonMobil’s (NYSE:XOM) two year extension for SeaDrill’s West Aquarius ultra-deepwater rig. The number of industry-wide newbuild orders for this class of offshore rig has increased by five units since late August and currently stands at 42 units. SeaDrill’s management expects the increased supply to be absorbed easily given the current high demand for these units. They are probably right, given the current fundamentals for the offshore industry. This is an area that investors should watch, however. If supply begins to outstrip demand, then dayrates would likely fall. This would have an adverse effect on revenues and profits of companies that operate in this industry. This does not, however, appear to be a major risk at this time.

SeaDrill continued to improve their balance sheet during the third quarter. The company reduced its overall debt per unit, although both current and non-current liabilities increased during the quarter. Shareholder’s equity, meanwhile, slightly decreased during the quarter to $6,772 million. The total debt to equity ratio stood at 1.46 at the end of the third quarter. This is still better than the 1.61 total debt-to-equity ratio at the beginning of the year.

SeaDrill’s net income fell substantially during the quarter but this was not due to any weakness in the company’s operations. In fact, quite the opposite is true. I mentioned earlier in this article that SeaDrill’s operating profit increased during the quarter to $480 million. This tells us that the company’s operations are doing quite well. Most of this large decline in net income from the second quarter was caused by the company taking a $330 million unrealized loss on derivative instruments, most of which are interest-rate swaps. (In addition, the second quarter’s net income was juiced due to gains that SeaDrill received from the acquisition of Pride International by Ensco plc.) It is important to remember that this was an unrealized loss. SeaDrill has suffered no actual cash outflow from this loss on their income statement. The company did generate enough cash during the quarter to pay their newly increased dividend.

Another negative factor that caught my attention in the company’s report is the potential for share dilution. At the close of the third quarter, SeaDrill had 467,099,774 shares of common stock trading in the market plus an additional 2,151,159 treasury shares. During the quarter, the Board announced that it is reserving 1.7 million shares of common stock to be used as senior management incentives. While I am generally supportive of this plan, I am concerned about the potential for stock dilution. If the company uses their holdings of treasury shares to satisfy the need for 1.7 million shares under this incentive plan then the impact on shareholders is likely to be negligible. Personally, I would be most supportive of this plan if the company purchased the required shares in the marketplace and thus avoiding the need to either reduce its treasury holdings or issue new shares. The phrasing that was used on the earnings release gives the impression that new shares will be issued to satisfy this, slightly diluting the stockholders.

Despite the few criticisms that I made here, I remain committed to my conviction that SeaDrill is an excellent investment and that the company has a bright future ahead of it. According to Yahoo Finance, analysts expect SeaDrill to earn $0.75 per share during the next quarter which is roughly in line with what the company generates solely through its operations. However, for some reason, the 2011 full year estimates stands at $2.87. SeaDrill has earned $3.25 so far this year so it has already beaten this estimate. In a previous article, I predicted that SeaDrill would earn $4.48 per share in 2011. Due to the company’s unrealized loss in derivatives this quarter, it is unlike that the company will achieve this. I am estimating that fourth quarter EPS will come in between $0.70 and $0.75. This is based on the company’s operations remaining strong and allowing for another minor loss on derivatives. This would bring my full year estimate to $3.95, barring a major surprises to either the upside or the downside.

Disclosure: I am long SDRL.