Seadrill Debt Plummets Along With Stock

| About: Seadrill Limited (SDRL)
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Summary

Seadrill debt has gone from trading at/near par to trading at a significant discount to par.

Seadrill's 2017 debt, which yielded less than 4% less than six months ago, now yields over 11%.

Debt prices can be the "canary in the coal mine" with respect to solvency risk.

Seadrill (NYSE:SDRL) stock has been pummeled and has declined more than any of the major players in the underwater drilling sector in 2014, with the Company's stock down 72% this year. Since suspending the dividend on November 26, the stock has fallen 45%. As the below chart shows, volumes have been high since the announcement, with the combination of investor rotation (income investors selling and traders and value/distressed investors buying).

Source: Yahoo!

The Company is deeply indebted, with over $14 billion in debt. By contrast, SDRL's market cap is less than $6 billion.

Source: FINRA via Morningstar

One could argue that on a valuation basis, SDRL is exceptionally cheap. However, in today's market, strong contracting seems to be ignored, while fear of where the freefall in WTI will settle and how production budgets will be cut takes center stage. SDRL's price drop, both in 2014 and since the end of the second quarter are both "market leading". SDRL's name also appears to have been blackened and in some circles the Company is seen as the poster child for excess and hubris (dividend rate, dividend suspension, high debt, Rosneft transaction, etc.).

Sources: Yahoo!, TDAmeritrade, FINRA via Morningstar, company's fleet reports

Given the change in market perception, I was interested in assessing how SDRL's debt had held up (on an absolute and relative basis). The Company's 2017 bond ($1 billion senior note) yield has almost tripled, going from an investment grade yield (not rating) of 3.88% on June 30 to 11.48% on December 10.

Source: FINRA via Morningstar

The Company's 2020 bond, which traded for par as recently as July 29, has fallen to $81.50.

Source: FINRA via Morningstar

SDRL's bond picture looks positively rosy when compared to subsidiary North Atlantic Drilling (NYSE:NADL), whose 2019 bond yields 18.8% (compared to "low" junk yield of 6.3% in July when the bond traded at/near par).

Source: FINRA via Morningstar

Bonds are not much discussed by stock investors. However, I would encourage readers to take a closer look. The best a bondholder can do is get a return of his/her principal (and interest). Therefore, at the slightest hint of risk to the principal, bond prices plummet. As a point of reference, non-investment grade, or "junk" bonds are currently yielding 6.3%, up slightly during 2014.

Both SDRL and NADL bonds traded either at a premium to par or at par in recent months. What makes SDRL's bond price drop particular is how recently and rapidly it occurred. As recently as November 30 (post dividend suspension), SDRL's 2020 bond traded at 95, only a slight discount; as of this writing, the bond is trading at 83. My point being, bonds are the "canary in the coal mine" with respect to solvency risk; up until recently, my focus was exclusively on what fair value of SDRL might be in light of changing macro conditions/events. Now the bond market is telling me I also need to consider other risks. To put it another way, previously I was analyzing what the value of SDRL should be and how long it might take to reach that value, now I must consider "if" it will reach that value.

This article only reflects the author's opinion. It is not designed, and should not be used as the basis of an investor's buy or sell decision. Investors should always conduct their own due diligence and make their own buy and sell decisions.

Disclosure: The author is long SDRL.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.