We are bullish on Seadrill Ltd (SDRL) because of its sustainable 8.4% dividend yield. The stock is trading at a PEG of 0.43x, much lower than its competitors. Moreover, its last quarter's EPS grew by 33% YoY. Seadrill has also secured a record revenue backlog of $20.3 billion for the second quarter of 2012.
With the demand-supply balance tightening due to increased demand and limited supply of offshore rigs, we believe that daily wages will continue to increase in the future. SDRL will continue to invest in growth assets and pay dividends, since its cash flow from operations have shown improvement YoY, and the company has secured its future revenues through contracts.
Seadrill Ltd is involved in providing international offshore drilling services to the Oil and Gas Industry. The company is headquartered in Hamilton, Bermuda, and has a market cap of $18.5 billion. The services provided by SDRL include drilling, maintenance and completion of offshore wells and well services.
SDRL operates a diverse fleet of 66 units, which include jack-ups, tender rigs, semi-tender rigs, semi-submersibles and deepwater drill ships; the company has the ability to operate in shallow-to-ultra-deepwater areas, harsh environment, and a benign environment.
North Atlantic Drilling Ltd (NADL) is a subsidiary of SDRL; the latter has a 74% stake in the former.
Industry Conditions and Outlook
The outlook for offshore drilling is strong; the key driver for offshore drilling services is the exploration and production spending undertaken by oil exploration and production (E&P) companies. Upstream spending has witnessed an annual increase of 10% from 2009, and this trend is expected to continue through 2013.
Expectations of increased exploration and drilling are expected to continue going forward, because:
- Oil discoveries are hampering production, and oil companies are struggling to achieve their production targets, as the backlog of development opportunities after the 2008 financial crisis is diminishing.
- Strong balance sheets of E&P companies allow upstream spending.
The demand and supply balance for ultra-deepwater rigs has narrowed due to high drilling activity, which has increased daily rates as well as durations of contracts. As per the estimates provided by SDRL, only five rigs are available in 2013; the market expects these to contract. The planning horizon for drilling companies has increased, as they consider securing drilling rigs available in 2014 due to the low supply of rigs for exploration.
The demand for ultra-deepwater rigs is mostly being driven by the increased drilling activity in the Gulf of Mexico and Africa. Drilling activity in the North Sea is strong, as the rig capacity for 2013 is contracted, and only a limited capacity is available for 2014 and 2015. Brazil is a core deepwater basin, and the ongoing demand in the region is expected to provide opportunities for rigs.
Building of New Rigs
Even though the demand for rigs is strong, orders for building new rigs have not shown an increasing trend. Only 16 new ultra-deepwater rigs (excluding Brazil) were ordered in the last 12 months, as compared to 23 rigs in the prior six months; out of these, 5 were ordered by SDRL. The company believes that new rigs will not be sufficient to meet expected demand, and is therefore negotiating to build additional rigs. The utilization of ultra-deepwater rigs for exploration drilling is 70%.
The demand for premium jack-up rigs is also expected to remain strong due to the increased drilling activity, which has increased daily rates and contract terms in most markets.
The utilization rates for these rigs have not been less than 90% since March 2011, and have witnessed an upward trend throughout. With the demand-supply imbalance expected to continue, daily rates are also expected to increase.
There has been an increased interest in tender rigs by oil companies due to their outstanding performance, which has increased daily rates and contract durations. SDRL intends to continue with its organic growth strategy to meet future demand for this segment.
SDRL has ordered 18 new builds at a total cost of $6.9 billion, which are expected to be delivered between 2012 and 2015, of which $1.6 billion has already been paid by the company; SDRL plans on ordering additional buildups.
The revenue backlog for SDRL has reached a record total of $20.3 billion, as reported by the company in its results for the second quarter of 2012. The average contract life for the company's floaters is 3.2 years. SDRL's burn rate is $1.1 billion per quarter, and the company's focus is to maintain the revenue backlog at these levels.
Revenue for the second quarter of 2012 was $1,087 million, showing an increase of 12.3% YoY.
The adjusted EPS for the second quarter of 2012 were $0.88, showing a YoY increase of 33%. Floaters contributed 71% of the operating profit, jack-up rigs contributed 12% and tender rigs contributed 16% to SDRL's profitability.
The increase in revenues and profitability is due to the increased daily wages earned by the company's rigs.
The cash flow from operations for the second quarter of 2012 reached $482 million, showing an increase of 90.5% as compared to the second quarter of 2011. However, the CAPEX also witnessed an increase of 43% to reach $460 million for the outgoing quarter.
Dividend Yield and History
SDRL is currently offering a dividend yield of 8.4%, and has paid out dividends for each of the last 12 quarters. The company has paid out a total of $4.6 billion over the last five years. SDRL has delivered a higher return to shareholders as compared to any of its peers through a high dividend payout and high growth via investing in high growth assets.
Given the several new contracts, a record high backlog, and strong operating cash flows, we are of the opinion that the company has the potential to continue its dividend payout, and it will continue to pursue aggressive growth, provided that drilling activity remains strong.
SDRL maintains a track record of safe and efficient operations, which is expected to result in existing clients renewing contracts, and increased opportunities with new clients.
Given the above factors, we believe that the company will continue to experience growth in all of its business segments with the demand-supply imbalance, which is expected to increase its daily wages further. The company has a record high revenue backlog with the increased duration of its existing and new contracts.
Even though SDRL is trading at premium P/E, EV/EBITDA, P/B and P/S multiples of 11.4x, 12.1x, 3x and 2.6x, it is offering the highest dividend yield (8.4%) in its sector, with tremendous growth opportunities. It has the lowest PEG ratio when compared to its peers. Therefore, we have a positive stance on the stock.
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