SeaDrill: Primed For More Gains

| About: Seadrill Limited (SDRL)

Summary

SDRL is expected to post a weak top line next week, but the company is capable of springing a surprise on the bottom line.

SDRL has achieved sustainable cost savings of almost $400 million in the past year, exceeding its own expectations, and this will help it beat the bottom line forecast.

SDRL has reduced its debt burden by selling off non-core assets and exchanging equity for debt, thereby leading to lower interest costs that will aid the bottom line.

SDRL is also keeping its utilization rates high by extending the duration of its contracts at lower dayrates, therefore avoiding stacking costs.

In a week's time, SeaDrill (NYSE:SDRL) will come out with its first-quarter results. Over the past three months, the stock has gained impressive momentum by rising almost 95%, driven by its announcement of restructuring the debt. The company has made some progress on this front in recent weeks, as we will discuss later. Also, I believe that investors should prepare themselves for a better-than-expected earnings report in the coming week. Let's see why.

Can SeaDrill beat the bottom line once again?

For the first quarter, SeaDrill's top line is expected to go down almost 29% to $889.6 million, while the company's earnings will drop to $0.38 per share from $0.71 per share last year. This is not surprising as SeaDrill has witnessed a continuous erosion of its backlog in recent quarters. For instance, at the end of the fourth quarter, SeaDrill had $5.1 billion in backlog, down from almost $6 billion in the preceding quarter.

As a result of the decline in the company's revenue, SeaDrill will see further weakness in its bottom line in the first quarter. But, it won't be surprising if SeaDrill actually manages to trump the bottom line estimate as it did last quarter. I'm saying this because SeaDrill has actually managed to increase its cost reduction forecasts for the current year, forecasting savings of $260 million as against the initial expectation of $200 million.

Additionally, last year, SeaDrill had achieved cost savings of $832 million as against its forecasted target of $600 million. Thus, on a year-over-year basis, SeaDrill's bottom line decline could be lower than expectations since the company has managed to reduce costs impressively. More importantly, a key reason why SeaDrill's costs will drop further is because 75% of its $260 million cost savings are expected to be sustainable, apart from 25% sustainable savings as compared to 2015.

Hence, all in all, SeaDrill has managed to clock sustainable cost savings of almost $400 million from last year, which should positively impact the company's bottom line in the first quarter and going forward.

More positives to consider

This year, SeaDrill has made a number of positive moves that will positively impact its business going forward. On one hand, the company has renegotiated contracts with customers in a bid to increase its backlog value and arrest the decline of its backlog, while on the other, it has been focused on improving its debt situation.

For instance, in the first quarter, SeaDrill added a net backlog of $190 million by entering into a contract for the West Eclipse in Angola. Apart from this contract, SeaDrill has also managed to bag a contract extension with Petrobras (NYSE:PBR) for 18 months. Although the contract value is worth $164 million, SeaDrill has been forced to take a haircut of $132 million due to a lower dayrate.

But, the positive part is that SeaDrill will be able to keep its drillship engaged for a longer period, thereby saving on stacking costs. As such, SeaDrill has done the right thing by accepting a contract at a lower dayrate since this will keep its utilization rate on the higher side and also protect the margins to some extent.

Apart from these moves to improve its backlog position, SeaDrill is also focused on improving the state of its balance sheet to extend its maturity positions. For instance, late in April, SeaDrill extended two of its credit facilities that were bound to mature this year, along with another facility that was set to mature in 2017. These facilities, together, were worth $2.85 billion. Additionally, this week, SeaDrill announced that it has entered into an equity-exchange agreement with lenders for $55 million worth of senior notes that were set to fall due in 2017.

Thus, it is evident that SeaDrill is trying hard to buy itself more time to satisfy its debt obligations and the good news is that its lenders are agreeing to the same. Moreover, the company has also resorted to asset sales so that it can bring down its debt burden. For instance, late in April, SeaDrill announced that it is selling its stake in SapuraKencana Petroleum for almost $195 million.

As a result of these asset sales, SeaDrill will be able to bring down its debt burden going forward, which will lead to lower interest expenses. In fact, SeaDrill has already made progress on its debt reductions as its debt position at the end of the fourth quarter was down to $9.9 billion as compared to $11.99 billion in the year-ago period, signifying a drop of 17%. This led to a drop of close to 20% in its interest burden.

Thus, as SeaDrill continues to improve its debt situation by way of asset sales and exchanges, it should be able to bring down its interest burden further, which will improve its bottom line profile going forward.

Conclusion

All in all, SeaDrill has made impressive progress to improve its financial structure and reduce costs, which will allow the company to do well in the long run. As such, I think investors should continue to remain invested in SeaDrill going into its earnings, despite the strong gains logged by the stock in the past three months since it can sustain its momentum going forward.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.