10.6% Dividend Yield, Extremely Attractive Valuation, Solid Long-Term Growth Prospects, Industry Leading Operational Performance
Seadrill Limited (SDRL) was founded in 1972 and has grown into a leader in deepwater and harsh environment drilling with the most modern fleet of all major offshore drillers with 17 floaters and 24 jack-up rigs that are in operation across Northern Europe, the Gulf of Mexico, Mexico, South America, Canada, West Africa, the Middle East and Southeast Asia. In addition, Seadrill is the majority owner of two master limited partnerships – Seadrill Partners (SDLP) and North Atlantic Drilling Limited (NADL), and manages three tender rigs owned by Malaysia’s SapuraKencana, one of the world’s largest integrated oil and gas service providers. Seadrill’s valuation also benefits from its significant financial investments in other service providers.
Shares Attractively Valued at 1.4x Cash Flow on Stellar Fundamentals
Seadrill shares closed at $37.71 on July 11, 2014, with a market capitalization of $17.7 billion (1.8x book value), a price-to-earnings ratio of 3.4x (lower than 90% of its peers in the oil well services and equipment industry but distorted by a sizable one-off EPS gain in Q1 2014) and price-to-cash flow of just 1.37x. Seadrill’s 46.5% operating margin is better than 96% of its peers suggesting industry-leading controls on costs and expenses.
As the comparison below shows, Seadrill’s peers lag significantly on floater utilization. This operational advantage and Seadrill’s excellent record on health, safety and the environment (HSE) give it a major competitive advantage on future contracts.
Over the past 12 months, Seadrill’s EPS growth rate has exceeded 93% of its peers and management has delivered stellar returns on assets, equity and investment capital, better than 97% of its peers.
At 10.6%, SDRL Offers Richest Dividend Yield Relative to Peers
Seadrill delivers a rich quarterly dividend of $1 per share ($4 annually) with a 10.6%
dividend yield –
the highest among its peers – and a payout ratio that is roughly 33% of its quarterly earnings per share. Quarterly dividend growth is one of the company’s key objectives, so it manages cash with shareholder dividend growth in mind.
The company has raised dividends by about 9% annually from $0.60 per share in Q1 2008 to $1 per share in Q1 2014 – with steady annual increases and no drops in dividend per share. Seadrill has also raised dividends for each of the past five quarters. So shares represent solid value for dividend investors.
In addition, EBITDA margins have risen from 34% in 2006 to 57% in 2012, and EBITDA is expected to climb at a significantly higher pace through 2016 as newbuilds add to contracted revenue in Growth Step II.
Shares Have Handily Outperformed S&P 500; Compelling Buy After Recent Dip
Seadrill shares have handsomely rewarded investors with capital appreciation that’s been well above the S&P 500. Shares have come under some pressure recently on misplaced concerns of a slowdown in demand for deepwater drill rigs but the company has $18.8 billion in contract backlog, continues to contract its rigs at very attractive day rates under long-term contracts, has significant revenue visibility (at least through 2016), has multiple new rigs under construction and is very well positioned to deliver earnings and dividend growth in the years to come, such as through North Atlantic Drilling’s strategic agreement with Russia’s Rosneft.
Based on consensus EPS growth estimates, FastGraphs expects shares to consistently rise over the next five years to about $72 by year-end 2019 with an estimated total annual return of 22%. So the combination of a solid 10.6% dividend yield, sustained 9% annual dividend growth and capital appreciation makes shares very compelling at current levels.
Newbuilds to Drive Revenue Growth
In Q1 2014, Seadrill took delivery of West Linus, a harsh environment high specification jack-up unit, and West Titania, a high specification jack-up unit. The West Linus unit began a 5-year contract with ConocoPhillips on May 25. Seadrill now has 19 rigs under construction with remaining yard installments of about $5.4 billion but has received notifications of delivery delays due to procurement delays. For now, Seadrill plans to hold off on ordering more ultra-deepwater rigs until it sees clear signs of renewed market demand.
Global Operational Footprint
Seadrill has a global operational footprint with a presence in key deepwater and harsh environment oil and gas locations. The April 2010 Macondo oil spill in the U.S. Gulf of Mexico (GOM) led to a drilling moratorium that was lifted in October 2013, more than three years later. GOM now has 41 deepwater rigs (including Seadrill assets), up from 33 at the time of the Macondo accident, with 11 more units scheduled to start operations by year-end 2014. Long-term, U.S. deepwater exploration and development will expand given GOM’s importance to the nation’s future energy security. Internationally, there is strong demand for active ultradeepwater units, and $100+ crude oil prices will continue to spur solid drilling activity.
Solid demand for high-end rigs from Mexico, Asia and the Middle East, growing demand from Russia, and solid forward utilization rates favor Seadrill’s young high-spec fleet.
Premium Offshore Driller with Modern Fleet
Seadrill is one of the largest offshore drillers (number of ultra-deepwater and jack-up units) with a modern fleet (the lowest floater and second-lowest jack-up average age) and exposure to premium segments (with over 90% ultra-deepwater floaters and 100% of its jack-up fleet with over 350 feet water depth capability) relative to major global competitors such as Transocean (RIG), Ensco (ESV), Noble Energy (NBL) and Diamond Offshore Drilling (DO).
$18.8 Billion in Contract Backlog
Seadrill has $14.1 billion in backlog on floaters (drillships and semi-submersibles) with 96% contract coverage in 2014, 66% in 2015 and 47% in 2016. In addition, it has almost $4.3 billion in contract backlog with jack-up rigs, with 90% contract coverage in 2014, 57% in 2015 and 33% in 2016. Seadrill also has $0.4 billion in backlog on certain tender rigs.
Deep and Ultra-Deepwater Premium Segment – Place to Be
As the graph below shows, shelf drilling has declined dramatically due to an exhaustion of in situ resources, and deepwater and ultra-deepwater now dominate discovered resources.
And, looking ahead, while shelf production is expected rise gradually, offshore production (barrels per day) is expected to rise sharply in the deep and ultra-deepwater segments. With its premium assets, Seadrill is very well positioned to benefit from this shift.
Due to continued strong offshore productivity, industry analysts expect demand for floater rigs to rise from 276 in 2014 to 455 in 2020 – an imbalance in rig supply and demand that favors contractors such as Seadrill and continue to hold contract day-rates at profitable levels. This imbalance will be bridged by newbuilds and help grow contractor revenues, cash flow and dividend payouts, while also providing wind for share price gains.
Financial Flexibility and Demonstrated Access to Capital
Seadrill has excellent access to capital through various innovative but low-risk financing structures. For example, the company recently received $356 million of $465 million in equity raised against its West Sirius and West Leo drilling assets, and $350 million of $400 million in equity raised against its West Auriga platform.
The company’s North Atlantic Drilling (NADL) subsidiary recently went public with a $125 million IPO and also raised $600 million through an unsecured bond, and is now independently financed and in a prime position to benefit from harsh environment drilling operations in addition to its materially meaningful contract with Russia’s Rosneft.
The company’s Seadrill Partners (SDLP) subsidiary recently launched a $1.8 billion term loan while creating a cleaner capital structure, with Seadrill Limited receiving $500 million in proceeds.
So its access to capital, high rig utilization rates (above 90%) and large backlog make this a very stable bet for the near term, with newbuild contracts expected to further strengthen fundamentals despite analyst concerns of a supply/demand imbalance and dropping day rates.
Q1 2014 Financials Reflect Contract Stability
For its first quarter of 2014, ended March 31, Seadrill had total operating revenue of $1.22 billion, down from $1.26 billion in the year-ago quarter due to the deconsolidation of Seadrill Partners and planned downtime on four rigs, partly offset by gains from full quarter operation on five other rigs. But a $440 million gain from asset disposals (West Auriga to Seadrill Partners) increased net operating income to $890 million, up from $552 million in Q1 2013. The company also reported a one-time gain of $2.24 billion from the deconsolidation of Seadrill Partners (effective January 2), which resulted in one-off net income of $3,094 million or $6.23 per diluted share.
Adjusting for one-offs, the company generated consolidated EBITDA of $788 million, 10.5% above the year-ago level of $713 million. For the quarter, Seadrill increased dividends
by $0.02 to $1 even, and had a consolidated orders backlog of $18.8 billion at quarter end.
In the quarter, Seadrill executed contracts for four jack-up units with Mexico’s Pemex and established SeaMex, a 50/50 joint venture with Fintech Advisory Inc. Seadrill also sold part of its West Auriga ultra-deepwater drillship to subsidiary Seadrill Partners for $1.24 billion that was financed through $416 million in equity and debt.
Post Q1, Seadrill secured contracts with revenue potential of $433 million, raised $300 million through the sale of 230 million shares of SapuraKencana (reducing its stake from 12% to 8%) and oversaw the signing of an Investment and Co-operation Agreement between its NADL subsidiary and Russia’s Rosneft, which includes Rosneft taking an equity stake in NADL.
At quarter end, Seadrill had $27.5 billion in assets, an increase in $1.2 billion over the quarter. Long-term interest bearing debt was down to $10.73 billion due to the deconsolidation. Total equity increased to $10.67 billion on gains from Seadrill Partners and NADL offerings, offset by a mark-to-market loss on its SapuraKencana stake.
Seadrill shares are partly down on a weak market environment with dropping dayrates as major oil companies improve their cash generation, as lower specification rigs drop contract rates to enter the higher end market and as oil companies hold off to see dayrates hit bottom. Once contracting activity picks up, rates will be lower than the rates contracted in 2013. But Seadrill should benefit from a newer, more modern fleet as competitors struggle with assets that are over 20 years old and require significant upgrades to stay relevant. Seadrill also has a strong cash flow profile because of its $18.8 billion backlog and limited exposure to current weakness in dayrates.
Onshore supplies (from shale, tight oil and non conventional drilling) alone cannot meet forecasted demand and offset production declines, and companies will look to deep and ultra-deepwater E&P to make up the difference – which is Seadrill’s sweet spot.
Overall, Seadrill offers a compelling dividend yield, and solid opportunities for revenue and dividend growth and capital appreciation. Investors should view current share price weakness as an excellent opportunity to establish a long-term position, and continue dollar-cost-averaging if shares fall on E&P market weakness because Seadrill’s long-term fundamentals are very compelling.