By P.I.A. - 8 months ago
About SDRL, PBR, OIH, SLB
Introduction and Overview An agreement has just been reached to drill for Brazil's offshore oil at its Libra Field, some 6,500 meters below sea level. The bidding process has been inauspicious as it results from the only offer, placed by a consortium led by Petrobras (PBR). Developing the field is projected to cost $184 billion, which leads to questions about whether it could mean business for any companies that offer equipment or expertise. The answer seems to be yes, and a firm that may benefit is Norway's Seadrill Limited (SDRL).
Petrobras is controlled by Brazil. It is affected in several ways that can be adverse to stockholders. While concerns about the corporation's profitability and future are regularly cited, it is taking strides to secure adequate resources for this project that benefits its government.
The Libra story only involves one location out of several around the globe that are favorable to offshore drillers. Some say the industry itself is poised to outperform. The Market Vectors Oil Services ETF (OIH) could make sense to investors. The fund tracks 25 international companies, with Schlumberger Ltd (SLB) comprising 20.6% of its holdings, compared to 4.3% SDRL. Even with the heavy weighting toward SLB, diversification provides safety.
In consideration of prospects for Seadrill, an overview of the new tasks at hand in Brazil is worthwhile. The Nephilimous deposits are known as "Pré-sal" because they lie beneath salt beds, under the ocean floor. The breadth and scale or the project is remarkable, and might be material for a future episode of Extreme Engineering. The corrosive salt layer itself is underneath the ocean, which spans over 2,000 meters from the surface.
Seadrill is the world's largest company of its kind. It is trying "to capitalize on Petrobas…" beyond the existing relationship. The firm has previously said it is "confident that Petrobas… will continue to require the services of at least their existing fleet of high specification floaters."
Operations and Investments
The Norwegian company has had three main segments: tender rigs, jack-up rigs and floaters. The tender rig business is now sold. Jack-up rigs are suitable for harsh weather. Floaters are used for deeper waters and should now account for an even larger percentage of net operating income than shown in second quarter figures below:
Of its Ultra-deepwater units (greater than 5,000 feet depth), the company currently has three semi-submersible rigs that are capable of use in water to 10,000 feet, and total depth of 30,000 feet. All of them have been located in Brazil and used by Petrobas (West Taurus, owned by Ship Finance; West Eminence; and West Orion). Several drill ships for use in 12,000 feet of water, and total depths to 40,000 feet, are under construction and scheduled to be available in 2014. New ultra-deepwater floating equipment is expected to perform better and be safer, in consideration of Transocean's (RIG) Deepwater Horizon Incident, which has ongoing implications.
A graphic from Seadrill's most recent investor presentation is persuasive:
There is contention that a modern fleet should command higher rates overall; though competition for the Libra field, and elsewhere, is likely (newbuilding, under Risks below). Seadrill's regional foothold is undeniable. It has recently acquired a controlling interest in Sevan Drilling ASA, which has activities in Brazil. Sevan's results are to be consolidated with Seadrill's this quarter. Further, the company has a senior vice president, Eduardo Antonello, who is responsible for activities in Brazil where its largest concentration of rigs is to be located.
Seadrill's existing backlog remains a strong point. There are $19 billion in future orders as of the second quarter, down from $21 in December 2012. The backlog should ease concerns about the safety of the dividend, which is discussed later.
The Norwegian driller has several investments in other companies. It holds roughly 12% of SapuraKencana Petroleum Bhp pursuant to sale of the tender rig business. There is also a Seadrill Partners LP (SDLP), after its October 2012 IPO, and its drilling units have been valued at a premium to Seadrill's own rigs. Seadrill owns 75% of SDLP and also 73% of North American Drilling.
Lastly, the company anticipates a significant increase in operating profit during the second half of 2013 due to new rigs.
Management has recently changed. Per Wullf is the new CEO, having occupied Fredrik Halvorsen's former post since July, 2013. More time is needed to evaluate his leadership.
The company's five largest customers accounted for 59% of backlog revenues in 2012. A serious problem with any of them would be material. Petrobras is particularly important.
Per its annual report, filed on a 20-F, Seadrill has $6.5 billion committed to newbuilding. As of the second quarter, nine new rigs are scheduled for delivery in 2013. Further, the company is now supporting Savan. Meanwhile, the worldwide fleet of ultra-deepwater drilling units is poised to rise from 128 rigs to 212, a 65% increase. Any lower resultant utilization and daily rates might be a problem, and can result in impairment charges if prolonged.
Financials are wobbly. The Altman Z-Score is 1.57, indicating distress that could result in bankruptcy within two years. Seadrill has roughly $11 billion in debt, about half of its market capitalization. A significant amount, $3 billion, matures in 2017 and could be a concern. Further, there are restrictive provisions and covenants. A serious incident or cash crunch could render it difficult to meet commitments to acquire new drilling units as planned.
Especially for those not based in Norway, there are numerous international risks.
Dividends and Valuation
Dividends to shareholders are somewhat irregular and result in varied figures from different sources. The yield for SDRL is extremely high, and payments have consistently increased. It is 9.25% in light of $4.33 recorded as paid out over the past year (source: Fidelity Investments). Dividend payments of $3.60 in 2013 should be made, in comparison to $3.36 last year (source: Sept. 4 Investor Presentation, 22 of 23), so 7.86% is a reasonable figure for the yield currently.
Using trailing 12-month EPS in GuruFocus' DCF calculator, shares are shown to be overvalued. If consensus 2013 EPS of $2.91 per share and a five-year growth rate of 25% (instead of 27.2% currently shown on YahooFinance) are input, we get a fair value of $54.76 without consideration of $13.21 per share in tangible book value. Further, the stock trades at 12.75x 2014E consensus earnings, which is based on 15 opinions, and under one half its projected five year growth rate. A case can be made that SDRL is an income-oriented bargain.
However, dividend payments exceed forecast earnings (rendering a Dividend Discount Model questionable). An outsized percentage of earnings has historically gone to shareholders, so this is not being viewed as a risk even though it might be.
Near Term Outlook
The unconfirmed date for third quarter earnings is Nov. 29. Consolidation of the Sevan acquisition is a consideration, as is the backlog. Meanwhile, the stock has run up this year since its lows in April. The 52-week high is $48.09, and shares currently trade at $45.80.
In the event of a pre- or post-announcement sell off, it could be advantageous to acquire stock. If the price somehow falls to 10% beneath the yearly high, to $43.28, an 8.32% yield would have terrific appeal. In consideration of the numerous risks, a further 5% decline to $40.88 might better balance things out. However, in light of compelling metrics, and also a dividend payout that can probably be expected to go higher, a near-term price under $41 might not be realistic.
Seadrill is a big, complicated company and one potential catalyst within a global footprint has been considered here. As such, to make sense for retail investing, valuation and growth prospects should be compelling and risks mitigated. While there can always be a favorable outcome for investors at today's share price, an improved proposition would make it compelling in comparison to the Oil Services ETF.