Will Seadrill Witness Further Downside?

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Nov 24, 2014

On November 26, 2014, Seadrill (SDRL, Financial) is expected to report its third quarter 2014 results and all eyes will be on the company’s earnings and certain specific news. This article discusses the potential factors to watch out for in the company’s earnings and the strategy to trade in Seadrill’s shares.

Among the factors to watch out for, the most important factors will be the company’s current dividend strategy. Seadrill is currently trading at $21.36 and the company offers a hefty dividend yield of 18.7%. I believe that the sustainability of this dividend is questionable and there will be something related to dividends in the company’s results or conference call.

Seadrill has maintained in the past that the company intends to keep dividends stable in 2015. However, a lot has change in the last few months in terms of decline in oil price, decline in offshore activity and certain challenges for Seadrill related to fleet renewal at higher day rates. All these factors will make the management reconsider the dividend strategy and I believe that the management will cut dividends.

Any cut in dividend can result in a negative near-term reaction in terms of the stock price. However, I believe that cutting dividends would be a great idea for Seadrill at this point of time. The company needs to have a more conservative financial strategy in difficult times and when the offshore drilling markets improve, dividends can again be increased. At this point of time, I am certainly in favour of cutting dividends.

The second critical factor that needs to be analyzed is the current status of the deal with Rosneft. It was earlier announced that the Rosneft deal with North Atlantic Drilling (NADL, Financial) has been postponed. However, no further details were available on the factors and I believe that the conference call will throw more light on the current status of the deal. If the management does not sound very optimistic on the outcome of the deal, the stock can suffer more downside.

The company’s outlook for the drilling market in 2015 is another key factor to watch. The reason is that a significant number of rigs are going off-contract for Seadrill in 2015 and the company needs to re-contract the rigs in challenging markets. Seadrill can provide early estimates on the likely day rates for 2015 and this will set the tone for the company’s operating cash flow outlook.

I expect that the company’s 2015 operating cash flow will be lower than that of 2014. The magnitude of decline in cash flow still remains uncertain and can impact the stock movement. I however feel that lower cash flows for 2015 is already discounted in the stock price and the stock can fall further in 2015 only if the rigs remain un-contracted for a prolonged period.

In terms of investment strategy, I believe that investors can remain in the sidelines and wait for any strong near-term negative reaction coming from cut in dividends or outlook for 2015. While the stock seems to have discounted the negatives, the markets can be volatile on the day the results are announced and investors should therefore be on the sidelines waiting for another 5% to 10% correction opportunity to buy the stock.

In conclusion, there are more headwinds for Seadrill in 2015 and investors need to remain cautious as the company tries to navigate through one of the most difficult phases. I am bullish on the offshore drilling industry for the long-term and I also believe that Seadrill has the potential to overcome the current crisis. However, investors need to wait in the sidelines (at least on the day of results) and consider gradual exposure to the stock. Since there can be more potential negative surprises in 2015, the best strategy would be to accumulate gradually and average down on any further decline. However, the investment horizon needs to be at least 3-5 years for strong returns.