Seadrill an Offshore Driller in Rapid Growth Mode
Energy Trends Finance
In This Issue
Seadrill Limited (SDRL)
Magellan Midstream Partners LP (MMP): BUY
Global Partners (GLP): BUY
Changes to Previous Recommendation
Seadrill an Offshore Driller in Rapid Growth Mode
Seadrill Limited (SDRL) is currently the largest offshore drilling company in the world by market capitalization of roughly $19 billion (B), and with an enterprise value of $29 B. The company boasts an exceptional dividend yield of 9.0% – a dividend of $3.52/share.
In the 1Q of 2013, SDRL beat market expectations for both revenues and earnings. SDRL, like most of the industry, is in a rapid growth mode seeking to capitalize on the explosive worldwide need for safer, better quality rigs in the post BP Gulf of Mexico oil spill to drill in more difficult and deeper waters – ultra deep to capture higher crude prices.
The speed of growth has stretched the balance sheet as the company is highly debt leveraged with debt to capital of 64%. However EBITDA to interest coverage ratio is nearly 7 times interest expense and EBITDA in the 1Q 2013 increased 20% from the comparable period in 2012. Since the 1Q of 2008, EBITDA growth on a YoY comparison each quarter has increased 18 out of 21 quarters.
To be sure, we are bullish on the long-term outlook for this sub-sector, as exploration continues to move further offshore to meet future energy demand needs. As I pointed out Thursday in my piece for the Energy Trends Report newsletter The Who’s Who of Deepwater Exploration:
“Today, roughly 80% of U.S. oil production comes from the GOM of which about 80% is from deepwater fields. Worldwide, the new sources of oil & gas discoveries are predominantly from deepwater — accounting for about 50% of all “new” conventional reserves, or about 7% of total conventional production and about 10% of global reserves.”
In particular, SDRL has recently moved into the Brazilian market looking to capitalize on Petrobras’ (PBR) explosive rush to develop its sub-salt discoveries. SDRL’s stock has strong tailwinds: elevated crude prices, and a high dividend yield coupled with good upside potential.
- With one of the more modern fleets in the industry, SDRL has the world’s second largest fleet of ultra-deepwater rigs and the largest fleet of jack-up and tender rigs.
- Rapid growth from five rigs in 2005 to currently about 60 rigs.
- It is the only major offshore drilling company with tender rigs in its fleet; a growing global niche market providing cost-efficient and flexible production drilling, as opposed to exploratory or developmental drilling.
- In addition, there is a lack of competition in the tender market that has resulted in a tight market for tender rigs. The net result of increasing global demand and tight supply has led to higher day-rates that SDRL is capitalizing upon, by re-signing rigs upon completion at higher rates.
- Well positioned for growth, the company currently has 14 rigs under construction in its portfolio to support its growth plans, or just under one-fourth of SDRL current fleet size.
To widen their competitive advantage and differentiate themselves from their peers, SDRL is not standing still. In 2012 they ordered two more ultra-deepwater drillships to be delivered in 2014. The cost of these ships is $600MM in total, but the opportunity for ultra-deepwater drilling is growing; indeed, demand may outstrip supply at its current pace and that would push rig dayrates higher. Daily rates for ultra-deepwater rigs are expected to increase to levels above $600,000 per day during the coming months, and total utilization of the ultra deepwater fleet nearly 100%.
The company has signed contracts for three semi-submersible rigs totaling up to $1.6 billion in potential revenue, all in the ultra-deepwater segment. In total, SDRL will have five new ultra-deepwater rigs scheduled for delivery in the period 2013-2014 and four existing units coming off current contracts in the same period. The growth in dayrates generates higher revenue while costs lag behind dayrates, leading to higher profits and cash flow supporting dividend growth.
- Riding the drilling wave into deeper waters has enabled SDRL to surpass its peers on EBITDA, operating and gross margins.
- No surprise that Seadrill’s stock has outperformed its peers since 2010, based on the strength of its operational advantages.
- Since 2008, its dividend has grown at a compound growth rate of over 30%.
- Free cash flow or operating cash flow less capital spending has been positive the last four consecutive quarters, and its levered free cash flow is positive.
- SDRL has an order back log of over $13 billion, counting major multinationals as ExxonMobil (XOM), Chevron (CVX), Petrobras (PBR), Statoil (STO), and Total (TOT) among its clients.
Over the last two years and even five years, SDRL has outperformed its peers: Transocean (RIG), Ensco (ESV), and Noble (NE).
Technically, SDRL exhibits positive momentum, above its 50 and 200 day moving averages, and establishing a floor of support at its 200-day moving average of $38/share.
BOTTOM LINE: Trading near its 52-week high, I like SDRL’s growth prospects and its high dividend yield. Given the growing need for newer, safer, higher quality rigs as older rigs are replaced, we recognize the short-term tradeoff between the increasing strain on the balance sheet to fund market growth with new rigs to realize long-term earnings upside growth. We would look to increase our purchases on any stock pullbacks. BUY.
Price Target: $46 over the next three to six months.
SeaDrill Limited (SDRL)
14 Par-la-Ville Road
Hamilton, HM 08
LOU GAGLIARDI’S CURRENT RECOMMENDATIONS
An important caveat for our readers: the energy market is increasingly volatile—an environment that is unlikely to abate. Depending upon your risk/reward tolerance, it is always a good idea to take some profits and look for lower re-entry points. To be clear, I select energy ideas with an eye to a long-term investment horizon. However, taking some profits is a good way to minimize your downside risk … how much depends upon your own individual risk/reward tolerance.
Magellan Midstream Partners LP (MMP): Stock continues to record growth to the upside, trading above its 50-day and 200-day moving averages. Continue to buy on pullbacks toward its 200-day moving average of 49.46, keep a firm stop-order limit at 47.00. BUY.
Global Partners (GLP): Stock has pulled above its 50-day and 200-day moving averages, a positive sign. I recommend buying on any stock pullbacks. Its long-term line of support is its 200-day moving average at 32.28. Continue with a firm stop-order limit at 30.00. BUY.
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