Seadrill (SDRL, Financial) is an offshore deepwater drilling contractor that provides drilling services to the oil and gas industry worldwide. The company has the most modern fleet of all the major offshore drillers and has a diverse asset base of 69 units. It operates in three segments: Floater, Jack-ups and Tender rigs.
The company’s asset base comprises of 32 6th generation ultra-deepwater units, two mid-water harsh environment semisubmersible rigs, 32 jack-ups rigs and three tender rigs.
In addition to a diverse asset base, the company has presence in all major oil and gas regions across the world. This diverse spread gives Seadrill a competitive advantage over other drillers in the industry.
Source: Company Presentation
In this article, I will discuss why the company will continue to create shareholder value and the drivers, which support this growth.
Financials
The first quarter 2014 revenue for Seadrill was $1,221 million compared to $1,469 million in the first quarter of 2013. The decrease was primarily due to deconsolidation of the Seadrill Partners and downtime of the West Alpha, West Phoenix, West Pegasus and West Polaris. There has been 61% increase in the company’s operating income primarily due to the gain on sale for West Aurgia. Increased earnings are also partly the result of the company’s deconsolidation from Seadrill Partners.
A deconsolidated statement does not indicate the uptrend in terms of revenue and EBITDA growth. However, a consolidated EBITDA increase of 11% y-o-y to $788 million in the first quarter of 2014 from $713 million in first quarter of 2013 implies that the company has been able to increase its profitability over the year.
The company has $12.4 billion as debt in its balance sheet and one would be wary to invest in such a high debt laden company. However, it is important to analyse the company’s interest paying ability before coming to any conclusion. The company has paid interest of $122 million for the first quarter and generated an EBITDA of $624 million for the same period. This translates into an interest coverage ratio to 5. Thus, a high interest coverage ratio indicates that the company earns enough at operational level to service its debt. I would therefore not worry about the high debt on the company’s balance sheet.
Attractive and Modern Fleet
Seadrill has one of the most modern and young fleet. The company is only second to Transocean when compared with the number of ultra-deepwater units. Also, the average age of the company’s floaters is the least for Seadrill.
What I personally like is that Seadrill has the highest exposure to premium segment compared to peers. Seadrill has more than 90% of its total floaters as ultra deep-water units. Also, if we look at the industry dynamics, ultra deep water rigs will have huge demand as production growth is likely to accelerate. The jack-up units of the company are also well positioned and have a competitive advantage over big players like Transocean (RIG, Financial) and Ensco (ESV, Financial).
Source: Company Presentation
Solid Contract Backlog and Revenue Growth
Seadrill has an impressive contract backlog of $18.4 billion, out of which floaters contribute $14.1 billion. Three ultra deepwater drillships - West Neptune, West Jupiter and West Saturn are due to be delivered in FY2014 along with a semi-submersible Sevan developer.
I believe West Jupiter would act as a high earnings asset for the company as the drillship has been contracted for a period of 5 years with a revenue potential of $1.1 billion. This would bring the company’s total contracted backlog to about $20 billion which is around 4 times the company’s revenue in the Fiscal Year 2013.
In addition to this, contract with a company like Total will help Seadrill deepen its relationship with key customers of the industry and also build their presence in Nigeria oil and gas industry. Also, blue-chip companies like Exxon, Chevron and Petrobras are the key customers of the company and this reduces the downside risk, ensuring a steady cash flow.
Industry Dynamics Support Growth
Both offshore and onshore global liquid production has been increasing and some of the biggest discoveries in the recent past have been offshore. Offshore ultra deep-water production growth is expected to increase at a CAGR of 19% from 2012 to 2030.
The percentage of ultra-deepwater units as compared to total floaters is more than 90% for Seadrill and with ultra-deepwater production expected to rise, the company surely will have a competitive advantage over its peers.
Source:Company Presentation
Global rig supply and demand imbalance would also favour rig contractors. The industry currently has a total rig count of 276 and 64 new builds are expected during 2014-2016 with 50 rigs retiring.
Hence, considering a likely demand of 455 rigs by 2020, the industry still requires 165 rigs. This gives plenty of opportunity to the contractors to meet the increasing production growth and ensures that day rates for rigs will remain high.
Conclusion
Though the company’s stock price has fallen in the recent past, I would recommend Seadrill as a strong buy. Seadrill has the most modern and young fleet which is ready to take full advantage of the strong industry dynamics.
Also, the company has a solid contract backlog with some of the big players of the oil and gas exploration industry, which would make the cash inflow firm. This, in turn, will have a positive effect on the company current dividend yield of 10.5%.
