Seadrill Still In Motion, But Delivering Better Utilization And Dividends

By Stephen D. Simpson, CFA | Updated May 28, 2013 AAA

Although I've had some issues with Seadrill's (Nasdaq:SDRL) aggressive (and highly levered) business plan, one thing really hasn't changed about this company – if you believe that various oil and gas majors are serious and committed to growing their production over the next five years, Seadrill is going to be a significant beneficiary. I sometimes wonder if Seadrill management is playing out some sort of deep-seated desire to be investment bankers with all of the elaborate deals and transactions they conduct, but the reality is that they are doing well in terms of contract coverage and dividend payments, and that counts for a lot.

Surprisingly Strong Fiscal First Quarter Results

Seadrill has disappointed investors recently some issues tied to government-mandated bolt replacements on blowout preventers, but this quarter's numbers came in quite strong.

Revenue rose about 20% from the year-ago level and 4% sequentially, good for a double-digit (11%) beat relative to the average sell-side estimate and a 7% beat relative to the Street-high estimate. The company's dayrates aren't much of a secret, and Seadrill outperformed due to meaningful improvements in utilization – floater utilization improved six points sequentially to 92%, while jackup utilization rose five points to 99%.

Seadrill runs a business with significant operating leverage, and so the higher than expected revenue had a definite positive impact on earnings. Operating income improved 11% sequentially, leading to a bigger outperformance against Street estimates relative to revenue, as well as a two and a half point sequential improvement in operating margin.

The Deals Never Seem To Stop

I don't know if there's ever going to be such a thing as a “steady state” for Seadrill. Unlike Transocean (NYSE:RIG) or Noble Corp (NYSE:NE), which largely buy and operate rigs, selling them when they've outlived their prime economic lives, Seadrill is far more active in managing its fleet and its capital structure.

To that end, the company recently announced the sale of a newbuild tender rig to Seadrill Partners (NYSE:SDLP) for $210 million. That of course pales in comparison to the nearly $3 billion transaction with SapuraKencana that effectively merges Seadrill's tender rig fleet with this Malaysian operator and gives Seadrill a 12% stake in its equity. Seadrill has also ordered another four new-build jackups (at nearly a quarter-billion dollars each) with delivery scheduled for 2015.

There are positives and negatives to this near-constant deal cycle. To some extent, it does allow Seadrill to leverage its advantaged access to capital and diversify its risk and revenue streams. On the other hand, I think any investor who lived through Enron has a certain skepticism and elevated level of concern when businesses are managed in overly complicated ways.

Still A Good Play On Production Growth

While the exploitation of oil shale and other unconventional onshore reservoirs has given major oil and gas companies new options to enhance production, I believe the fact remains that offshore oil and gas exploration is going to play a major role in the growth of the energy sector in the coming years.

To that end, Seadrill's better-than-70% contract coverage over the next few years is a strong positive – companies like Atwood (NYSE:ATW) and Ensco (NYSE:ESV) with lesser coverage have more upside to higher dayrates, but more risk as well. Likewise, nearly 50% of Seadrill's contracts are with BP (NYSE:BP), Total (NYSE:TOT), and Exxon Mobil (NYSE:XOM) – well-financed international energy majors with clear plans to increase production over the next three to five years and significant commitments to offshore energy development.

The Bottom Line

There's always the risk that another catastrophic offshore accident/oil spill could freeze the market, but that's a risk common to any offshore driller or provider of offshore energy equipment and services. Likewise, the high level of debt on Seadrill's balance sheet would likely threaten the company's survival were something to fundamentally change the offshore drilling market and wreck dayrates.

With those risks go the possibility of reward. Seadrill already pays a hefty dividend and the company's management has positioned the company to make the most of the upcoming surge in offshore drilling activity. I do believe that Seadrill remains overpriced on these prospects (and that Transocean is undervalued), but I won't underestimate the potential for the stock to outperform if management continues to deliver strong quarters and investors start another scramble in offshore service stocks.

At the time of writing, Stephen Simpson did not own any shares in any of the companies mentioned.

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