Friday, February 26, 2016

Seadrill - It Is Still A Very Decent Company

Seadrill (NYSE: SDRL) is a drilling offshore contractor offering its services to petroleum / natural gas explorers / producers. The company holds a modern fleet of various drilling and auxiliary vessels, as, for example, jack-up drills, semi-submersible platforms, tender rigs etc. Seadrill rents these vessels to oil-majors, which use them to look for oil and natural gas.

                                                 An example of a semi-submersible platform

For many years the company was a kind of a tasty morsel for many investors, mainly due to excellent financial results and generous dividends. Additionally, Seadrill is controlled by a multi-millionaire sea - industry tycoon, John Fredriksen.

When oil prices started their bear market, Seadrill shares crashed:

Well, I agree that the company was too optimistic about its future. Due to heavy investments and generous dividends the debt level increased significantly. However, despite the currently lower demand from oil-majors (sales went down from $5.28 billion in 2013 to $4.34 billion in 2015) Seadrill, in my opinion, is able to service its debt.

I would picture this situation through these two charts. The first one shows debt levels and dividends. To make things clear, I present cumulative dividends (the pink area shows total dividends paid since 2008):

in millions of USD

As the chart shows, at the end of 2015 the company was holding debt of $11.13 billion. Since 2008 it has paid $8.0 billion in dividends so it means that if Seadrill had been not paying any dividends its debt would have stood at just $3.13 billion now ($8 billion less $3.13 billion consumed by paid dividends). Simply put, the company is a victim of its generosity.

Additionally, Seadrill is a living example of the theory that heavy investment (since 2008 it invested as much as $20.6 billion!) plus high dividends is a very toxic mixture, which may kill even a decent company.

Despite that I believe that the company is still able to service its debt.The chart below shows its net debt (debt - cash) and a ratio of net debt to ebitda, which is widely used by creditors to assess a liquidity / insolvency risk:

in millions of USD

It is acknowledged that a "safe" ratio should stand at around 2.0. In the case of Seadrill, since 2009 it has been standing at around 4.0, so it was way above the safety limit. However, in good times the creditors were not afraid because the company was increasing its sales, had reliable customers and was delivering sound financial results.

Today it is different. But only a little bit. Oil and gas prices are much lower than in 2014 and demand for the company's services is definitely lower. But Seadrill still delivers decent results.

Despite the fact that the company's results are good, I guess that creditors do not fell comfortable.

Well, in my opinion they exaggerate - please, look at the chart below:

in millions of USD

The chart shows the debt payment schedule. This year Seadrill has to repay $1.52 billion. In 2017 it should repay $2.87 billion, etc. Is the company able to do it? Let us look at the company's free cash flow:

in millions of USD

Free cash flow is defined as cash from operating activities less cash from investing activities. As the chart shows, in 2014 and 2015 the company delivered positive free cash flows, $1.64 and $1.60 billion, respectively.

I believe that Seadrill has one of the most modern offshore rig fleets in the world so there is no need to invest vast amounts of money to build this fleet further. Therefore there should be no problem for the company to generate the annual free cash flow of around $1.60 billion in the coming years, even taking into account today's low oil and gas prices. With such cash flow the company is able to repay its 2016 debt of $1.52 billion.

There is only one big problem, which may endanger the company - new drilling contracts may be signed at lower prices. The table below lists a few drilling contracts and their day rates:

Some of these renewed contracts were signed at lower prices (for example West Phoenix) but part of them presents better conditions than before (West Aquarius).

Finally - the chart below shows current valuation metrics (EV / EBITDA and P / BV):

As it is easily seen, today Seadrill shares (market price of $1.90 a share) are trading at:

  • EV / EBITDA of 4.40
  • P / BV of 0.09

I do not risk too much saying that Seadrill shares are totally undervalued.

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