Seadrill (SDRL, Financial) has suffered immensely after a steep decline in oil prices. The stock has slumped by 70% in 2014. Seadrill’s decline has been accelerated by the fact that the company has $13 billion in debt and high leverage can be a big problem in difficult times. Seadrill’s decline was also accelerated by the fact that the company suspended dividends.
However, after touching a low of $10.66, Seadrill has bounced back by nearly 16% to current levels of $12.36. This article discusses if the worst is over for Seadrill and if the stock can be considered for exposure at current levels.
I am of the opinion that investors still need to remain on the sidelines before considering exposure to Seadrill. There are several reasons for this conclusion and I have discussed the key reasons in some details.
The first reason is that I don’t expect oil prices to surge back in 2015. The global economy is slowing down and there is a supply glut. Both these factors ensure that oil will remain at about $60 to $70 levels in 2015. With offshore oil break-even at higher levels than $60 per barrel, I believe that the offshore drilling market will remain weak through 2015. Therefore, there is no reason to believe that Seadrill will move significantly higher in the coming quarters.
The second important reason to remain on the sidelines for 2015 is the company’s contract status. While Seadrill has a strong long-term contract backlog, a large number of rigs are going off-contract in 2015. It still remains to be seen at what rates the rigs are re-contracted and if a number of rigs are cold stacked. This will determine the company’s cash flow outlook for the coming year. With the current cash flow outlook remaining uncertain, its best to stay on the sidelines with overall market conditions remaining weak.
The third reason is the uncertainty related to the Rosneft deal, which involves North Atlantic Drilling (NADL, Financial) and Seadrill. Considering Russia’s current scenario, it seems increasingly unlikely that the Rosneft deal will go through. The cancellation of the deal will be yet another setback for the company.
Besides these three important reasons, it also remains to be seen how Seadrill manages to lower its debt in these challenging times. For the period September 2014 to September 2015, Seadrill has $1.7 billion in debt maturity, $4.8 billion in new build commitments for 2015 and a potential cash outflow of nearly $500 million on debt servicing. In addition, Seadrill also plans to repurchase shares in 2015.
It remains to be seen how Seadrill can manage all these commitments and I believe that Seadrill can potentially sell some assets to reduce debt. While asset sale can reduce debt, it will also reduce the potential cash flows.
Therefore, there are several factors on the horizon that will determine the future of Seadrill and investors need to patiently wait for these factors to play out before considering exposure to the stock.
I can say with conviction that Seadrill will not resume dividends through 2015 and I also believe that the stock has minimal upside potential in the coming year. There is no doubt that Seadrill has done exceeding well when market conditions were good, but high leverage is the trap for the company in difficult times and it remains to be seen how Seadrill escapes from the trap.
In conclusion, my advice is to stay away from Seadrill until there is a clear picture on the points that I have discussed in the article. After a correction of 70%, a bounce back of 10% to 15% is likely. However, the sustainability of the bounce back remains uncertain.
