Since the offshore markets started to look challenging and oil prices commenced a steep decline, my recommendation to stay in the sidelines has worked in relation to Seadrill (NYSE:SDRL) with the stock down 70% YTD. After plunging to low of $10.66, Seadrill has seen some recovery and is higher by 18% to current levels of $12.6.
I believe that this is a temporary rally and Seadrill can again trend lower or remain sideways in the coming year. I therefore hold on to my recommendation of "Staying in the Sidelines" and this article discusses the biggest challenge for Seadrill in 2015.
As of September 2014, Seadrill had a debt of $13.1 billion and this is the biggest challenge for the company in the coming year. The reasons for considering the debt burden as a big challenge are as follows -
- Seadrill's annualized operating cash flow for FY14 comes to $1.7 billion. In FY15, the company's operating cash flow is likely to decline on lower day rates. While it is still early to predict the cash flow, it will be significantly lower.
- Seadrill's annualized interest outgo for FY14 comes to nearly $500 million. The company's interest outgo for FY15 is likely to increase. Again, it is early to predict the interest outgo, but a higher interest outflow is certain.
- Seadrill has $4.8 billion in payments scheduled for new rigs in 2015 and this is the first reason to believe that interest payment will increase as the new rig has to be funded through debt on lower operating cash flows.
- Between September 2014 and September 2015, Seadrill has $1.7 billion in debt maturity. I believe that all this debt will be refinanced. The important point is that all the debt will be refinanced at a significantly higher cost as the risk related to the industry and company has increased significantly. This is the second reason to believe that Seadrill's interest outgo will increase in 2015.
- Seadrill has also received the board authorization to repurchase up to 10% of the outstanding shares. How will the share repurchase be funded considering the operating cash flow, new rig payment due and the debt refinancing? I believe that Seadrill is unlikely to take more debt to buy back shares. I therefore expect a rethink on share repurchase in FY15.
The $13.1 billion debt burden will not decline in 2015 even with dividend suspension. I expect Seadrill to consider selling some existing assets or new rigs (provided market conditions allow the sale). If the sale is through, the debt burden might decline, but the potential cash flows will also decline.
In other words, even after the suspension of dividends, Seadrill is not in a position to reduce debt in 2015. I must add here that Seadrill also has $666 million in capital expenditure commitment in 2016 and if some of 2015's capital expenditure is pushed into 2016, the burden will only be extended in uncertain market conditions.
Therefore, the challenges are in plenty for Seadrill in the coming year and the debt, debt re-financing and the financing of new rigs will be the biggest points to watch out. While Seadrill can sell assets as mentioned above, a distressed sale can also sent the stock plunging.
Besides the debt problem, I also view the Rosneft (OTC:OJSCY) deal finalization with a great degree of skepticism considering the crisis Russia is going through. If the deal stands cancelled, it will be a blow for North Atlantic Drilling (NYSE:NADL) as well as Seadrill. I do see North Atlantic Drilling discounting a lower probability of the deal getting finalized.
The biggest savior for Seadrill will be a recovery in oil prices. Unfortunately, Saudi Arabia has again reiterated that it would not cut oil output in order to prop up prices. I therefore expect a gloomy first half of 2015 for oil prices. The trend in the second half of 2015 will largely depend on the level of weakness in the global economy.
In conclusion, there are several challenges for Seadrill on the horizon and investors need to stay cautious even when the stock seems to be trading at attractive levels. I want to conclude saying that I still consider that Seadrill can bounce back. However, the current market conditions mean that the stock will not be a performer in 2015.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.