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.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

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.

SEE: Analyzing An Acquisition Announcement

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.

SEE: A Guide To Investing In Oil Markets

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.

SEE: 5 Must-Have Metrics For Value Investors

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

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

Related Articles
  1. Chart Advisor

    Rare Earth Metals Continue To Struggle

    Rare earth metals are used in many of today's products and many investors are wondering if consumer demand is enough to offset the global economic slowdown. We'll take a look at how they are ...
  2. Stock Analysis

    Will J.C. Penney Come Back in 2016? (JCP)

    J.C. Penney is without a doubt turning itself around, but that doesn't guarantee the stock will respond immediately.
  3. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  4. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  5. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  6. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  7. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  8. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  9. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  10. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center