Seadrill (NYSE:SDRL) has fallen further since I last wrote about the stock -- my previous article was published on Dec. 6 -- and I argued that the stock might be close to bottom, and it might be a good time to buy Seadrill. However, the stock has continued its slide further due to a number of reasons. The main reasons behind the fall remain the same -- a continued fall in crude prices, high debt ratios, and the expected lawsuits from the shareholders.
I stated in the above-linked article that the fallout from the OPEC decision will likely continue for the next two weeks and we will see price shocks in the crude oil market -- I still believe that crude oil will likely fall further before making a recovery. As crude oil is a major commodity and a number of sectors are dependent on this commodity, a fall in the stock prices of oilfield services companies is not a surprise. In fact, some savvy traders have made handsome profits by shorting oilfield services stocks after OPEC announced that it is not going to reduce output levels. So, the first factor remains unchanged and I do not believe this factor will work in favor of Seadrill or other oilfield services companies in the short term. Crude prices will remain low and under pressure for some time, and the oilfield services companies might face further problems.
For Seadrill, one of the main upside points in our thesis has been the strong order backlog of the company, which still stands at close to $20 billion. There is a danger that if the slide in the crude prices continues, then there might be some cancellations. Order backlog provides earnings and cash flows visibility, and it is an important factor while making an investment in off-shore drillers. During the earnings call, the CEO emphasized that the contract situation of Seadrill was very much under control and the company will likely not face a total loss if the cancellations happen.
However, if crude prices remain under pressure for a prolonged period and cancellations start to happen, the company will land in serious trouble, in my opinion. At the moment, Seadrill can continue to generate enough cash flows to meet its interest obligations, and a reduction in debt should even make it stronger. Before we start to talk about bankruptcy, I believe Seadrill will have to see a strong number of orders cancelled.
Moving on to the class action lawsuits -- some law firms have started to target the company in order to have a payday. This is nothing new; law firms have been using this tactic for quite some time. These lawsuits might become lengthy and cost the company in legal costs, but I do not think the accusers will be able to prove guilt on the part of Seadrill. The company reaffirmed its stance to maintain its dividends at the end of the second quarter -- at that time, crude prices were falling but at a very slow rate; the majority of the players in the market did not expect crude prices to go below $60 at that point.
In my opinion, Seadrill management also did not expect crude prices to take such a hit, and they were confident that the company can take a small hit. However, over the next three months we saw a steep decline in crude prices, which certainly forced some of the customers of the company to reconsider their capital expenditures policy. As a result, Seadrill also had to make adjustments to its own capital plan. Furthermore, it will be really difficult to prove intent to mislead investors.
As I mentioned in my previous article, Seadrill investors have lost a lot and most of the shareholders are holding on to their shares at a considerable loss. There is another factor to consider here: The company has suspended dividend in order to pay debt -- which most of the industry specialists have wanted the company to do -- reducing debt and making the company a stable entity. That is in shareholders' favor, not against them, and this will also likely go in favor of the company. These lawsuits are certainly having an impact on the stock price, but I do not think Seadrill is under threat from lawsuits. Also, it is premature to talk about bankruptcy as a lot will still have to go wrong for Seadrill to go bankrupt.
John Fredriksen has made two efforts over the last few weeks to give some support to the falling stock price. The first attempt was at the end of September when the billionaire increased his share in the company. However, the price continued to fall as the crude prices were still under pressure. On Dec. 5, John Fredriksen bought shares worth $33.5 million, which took his total stake to close to 24%. Again, this transaction can be taken as an effort to send a signal to the market and shareholders that there is no need to panic -- there is nothing wrong with the company and the owner is not afraid to put his own cash in the company. At the moment, the fall in the stock price for Seadrill is mainly fueled by fear, in my opinion. The stock is trading at a substantial discount to the book value (explained in the above-linked article), and this transaction by Fredriksen is a good sign for investors.
The Bottom Line
Seadrill's stock price will likely remain under pressure for some time, but I maintain that the bottom is near. Shareholders face substantial losses if they sell at current price levels. However, in my opinion, holding on to the shares is a lot better option than selling right now for a number of reasons. Crude oil prices will certainly make a recovery once the fallout from the OPEC decision subsides and the prices establish a bottom. However, we will have to wait for prices to make a recovery as the supply glut will continue in the short term. Nonetheless, as prices start to recover, Seadrill will be one of the early and primary beneficiaries.
Furthermore, lawsuits are currently pushing the price down. In my opinion, Seadrill will be able to come out unscathed from these lawsuits -- this is another expected positive for the company. Finally, reduction in debt will make Seadrill a more stable and stronger entity, which should make it even more attractive to investors. I maintain that Seadrill will get out of these troubled waters and the stock will make a recovery.
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