After a big rally off the bottom, Seadrill (NYSE:SDRL) has lost over 50% from the recent highs to start March. The valuation proposition of this offshore driller reminds us of some of the stocks following the Great Recession. Since the March 9, 2009 lows, General Growth Properties (NYSE:GGP) has returned nearly 100% annual returns.
Seadrill appears to fit the similar situation with strong assets, yet a lot of debt incurred to build a modern fleet of offshore drilling rigs. At slightly over $3, Seadrill trades for a fraction of the book value that sits at over $15. With nearly $10 billion in net debt and a book value of close to $10 billion, the stock could plunge to $0 or skyrocket in the next couple of years.
Limited Backlog Beyond 2017
The story with Seadrill has become one of survival until the market rebounds. For now, the offshore driller has a modern fleet with a decent amount of backlog through 2017. The big issue is the ability to survive in 2018 if the market doesn't rebound.
Source: Seadrill Q4'15 presentation
A prime example of the issue is the contract extension for the West Tellus that added 18 months to the contract and only $32 million to the backlog. Of course, any contract with Petrobras (NYSE:PBR) is about survival and not profits.
The deal keeps another rig in work during 2018 and 2019, but the contract was at a cost of around $0.05 per share on 2017 estimates according to Evercore ISI.
Despite trading at below 20% of book value, Seadrill is still a highly profitable company. In the last quarter alone, the company generated $316 million in operating income and $513 million of EBITDA. Analysts still forecast, the offshore driller generating a profit next year despite more rigs coming off contract. Of course, a profitable 2017 is very much in question with some analysts forecasting a loss.
Source: Yahoo Finance
Amazingly a lot of offshore drillers like Diamond Offshore (NYSE:DO) and Ensco (NYSE:ESV) are forecasted to generate profits next year. The big difference is that Seadrill is the one that trades the furthest below book value.
The large variance in valuations is that Ensco and especially Diamond Offshore don't carry the same debt loads as Seadrill. As well, these offshore drillers don't have the same modern fleets that will thrive when the market rebounds.
The balance sheet rules the investment thesis for now, but at any signs of a turn in the offshore drilling business the modern fleets will rule the stock returns.
At this point, Seadrill is the best offshore driller to play if the market rebounds by 2018. At the same time, the company is probably one of the worst plays if the sector takes until 2019 or later to rebound.
The one big caveat is whether Seadrill obtains new funding from major owner Fredriksen that would guarantee survival during the current downturn. Any positive deal would send the stock soaring regardless of the time frame of a rebound in the offshore drilling market.
Trying to catch a bottom is always risky so investors should always tread with caution understanding the risks.
Disclosure: I am/we are long SDRL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.