There are a lot of energy industry veterans who believe that only the conservative survive, and it's not hard to see where they're coming from - companies that have levered up and expanded aggressively during booms have often been the ones to go bankrupt during the inevitable busts. Seadrill (NYSE:SDRL) is hoping to blaze a new trail, though, and the company's large new fleet should reap the best of what this upsurge in offshore drilling activity has to offer.
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A Surprisingly Dull First Quarter
Seadrill has been very active in mergers and acquisitions and strategic investments, new build commitments and so on, and this has dominated a lot of the discussion around the stock. In terms of actual on-the-water business, though, conditions have been a little more sedate.
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Revenue in Seadrill's first quarter fell 5% from last year and 1% from the prior quarter, but that was more or less in line with most analysts. Utilization was exceptionally strong in the first quarter, at 94% for floaters and 98% for jack-ups, and only one unit was not under contract in the company's rig update.
As has been reported at larger rival Transocean (NYSE:RIG), dayrates have been moving up - particularly in the ultra-deepwater and harsh environment categories. It's also worth noting that Seadrill, like Ensco (NYSE:ESV) and unlike Transocean, has been reporting very solid uptime. Not only does this mean that the company is maximizing its profitability, but it also makes the company's clients happy.
While revenue was a little sluggish, profitability improved in the quarter. Seadrill saw EBITDA rise 4% from last year and 3% from the fourth quarter, and margins improved nicely.
Continuing to Build the Fleet
Seadrill already has the second-largest offshore fleet, but the company is not through building. The company has commissioned four more rigs at a cost of over $2 billion. In particular, the company has concentrated a lot of its capital on building out its ultra-deepwater fleet; ultra-deepwater being the area of offshore drilling that has always generated the highest per-rig dayrates.
Certainly there are risks in building these ships, but the company has had little trouble in signing up companies like Total (NYSE:TOT) to multi-year contracts. Moreover, energy services can be a "you snooze, you lose" market where other drillers will take up shipyard space with their own orders before too long. It's also worth noting that new builds are likely Seadrill's best growth play, as the older fleets at companies like Diamond Offshore (NYSE:DO) don't offer the same prospective returns.
Where's the Line That Marks "Too Aggressive"?
Seadrill definitely runs on a different plan than most other offshore drilling companies. Not only has Seadrill taken on quite a lot of debt to fund its rig-building plans, but the company also pays a sizable dividend and is even considering forming a master limited partnership (MLP). Conservative investors aren't going to like this; "creative" and aggressive financing plans in highly cyclical industries can be very dangerous to long-term investors.
On the other hand, it's hard to look past the company's strong contract position and a nearly $14 billion backlog. It's also hard to believe that the offshore drilling plans of major offshore operators like Total, Exxon Mobil (NYSE:XOM) and Statoil (NYSE:STO) won't continue to push dayrates higher. Surely there is a risk from competitive spec builds saturating the market, but that has traditionally been more of an issue in the cheaper-to-build jack-up market than in the ultra-deepwater and harsh environment markets.
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The Bottom Line
Seadrill simply does not work as a stock from a valuation standpoint. The company has committed billions of dollars to new builds that will not contribute revenue for a year or more, and that skews the relationship between the company's near-term EBITDA and net debt position. So an investor applying the customary enterprise multiple seen in the past for companies like Transocean and Ensco are going to come away from Seadrill thinking that it is quite expensive.
Looking further out, it's probable that Seadrill is going to report very impressive revenues and profitability in 2013 and 2014. That said, it's likely that Ensco and Transocean will as well, and there is a solid chance that the leverage of Transocean and Diamond to a tightening floater market will help them even more.
Seadrill is the aggressive play on offshore drilling demand. If the market stays strong and tight, this stock could work. That said, the aggressive expansion undertaken by management does up the risk in this name considerably.
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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.