I wrote about Seadrill (SDRL, Financial) on November 24 here on GuruFocus, and I had the opinion that Seadrill is likely to cut dividends as it announces its Q3 2014 results. I also advised investors to remain in the sidelines as negatives related to dividend cuts can result in further decline in the stock.
As Seadrill announced its results today, the stock declined by 15% in the Oslo stock exchange, and the reason for the big decline in the stock is the fact that Seadrill has suspended dividends until the overall offshore market conditions recover. I hope that investors would have largely adopted the strategy of remaining on the sidelines before the results.
The reason for dividend suspension as stated by the management is to focus on reducing the company’s debt burden. According to Seadrill, the suspension of dividends would allow the company to save $2 billion on an annual basis.
This is certainly a positive step considering the fact that Seadrill has a debt burden of nearly $13 billion and the company has a capital expenditure of $3.9 billion in 2015 and 2016, which has to be funded by debt. With an annual saving of $2 billion, the company can reduce the debt burden in difficult times.
Further, the company’s operating cash flow for the first nine months of 2014 was $1.2 billion. I expect the company’s operating cash flow to decline significantly in 2015 as some rigs go off-contract. These rigs can face idle time or get contracted at a lower day rate. With all these considerations, the decision to suspend dividends seems right even if it means that the stock will slide in the near term.
The important point to watch will be how soon the offshore markets recover. The longer the delay in the recovery of offshore markets, the bigger the pain for Seadrill.Ă‚
Seadrill has also received board authorization for share buyback of up to 10% of the total shares outstanding. While the buyback can happen at very attractive levels, I believe that the current focus for Seadrill should be on reducing the debt from the funds the company holds. Share buybacks will require further funds, so this would have been a better strategy when the company was in a better financial position.
Another factor that can still depress Seadrill is any potential cancellation of the deal with Rosneft. Currently, the deadline for the deal has been extended to May 2015. It remains to be seen if the deal goes through amidst difficult market conditions and rising tensions between the West and Russia.
Seadrill has a robust order backlog of $20 billion and that remains a positive factor for the company. The revenue visibility is strong even if the cash flow visibility has declined due to difficult market conditions.
From a growth perspective, Seadrill currently has 16 rigs on order and as these rigs become operational over the next 2-3 years, the company’s revenue and cash flow will witness upside. However, the key factor is the recovery in oil prices and the offshore market. Once that happens, Seadrill will be well positioned to grow again at a strong pace.
In conclusion, Seadrill’s nightmare year in terms of stock downside continues as the stock is certain to take further beating when it opens for trade today. Investors still need to avoid Seadrill as there can be further negative events. However, the stock will provide a long-term buying opportunity over the next 6 months.
