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Seadrill: "They Lease Rigs to the Big Boys"

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May 13, 2014 – Comments (8) | RELATED TICKERS: SDRL , RIG , SDLP

Seadrill is a company that kept showing up on my screens, and I thought "huh, sounds like a competitor to Diamond Offshore and Transocean, why have I never heard of them."  I kept making a mental note to follow up, never did.

Well earlier this morning I posted/complained here that I found nothing - no, nothing, not a thing, Alfred - that I could bear the idea of being invested in - no, Alfred, not for a moment - and so when awallejr commented on my post, noting that he saw 'a ton' more attractive than cash, my ears perked up. 

And when he mentioned SDRL, I thought, hm, that's one coincidence too many.  I'm going to take a look here.

They haven't been around very long and they have a funny capital structure.  They came public in 2011 and promptly took on huge debt, started building new rigs and leasing them out.  As far as I can tell, management is heavily populated by old Norwegian oilmen and young London financiers - winning combination, seems to me - and indeed they've done well, posting stratospheric earnings and dividend growth and maintaining an unheard of 58% gross margin.  Debt to equity is about 180% today; debt to assets, probably a better metric for a leasing company, is about 58%.  Payout ratio is about 79%; the eye-popping yield is currently 11%.

There is some complexity; they own part of an MLP, Seadrill Limited Partners, to which they are frequently spinning off assets.  The MLP yields 6.6%-ish; because of the way MLP dividends are treated, you have to back them out of your IRA with annoying and time-consuming paperwork (important when your accountant gets paid by the hour) with the result being, you might as well hold the MLP shares in your taxable account, where the dividends are very favorably treated indeed due to tax-favorable pass-throughs inherent to the MLP structure.  As far as I can tell SDRL also owns and receives minority interest income from two other well drillers, although I haven't deep-dived the financial statements to learn more about that.

The bull and bear cases are not complicated, despite the above.  The bull case is that Seadrill's rigs are state of the art, young rigs, optimized for deep and ultradeep drilling and submersible drilling, built with the latest tech, efficient with the least downtime, and can access oil that other players' rigs cannot.  Evidence of this is plentiful and boils down to the fact that XOM and other major players seem to be keeping SDRL's rigs fully employed and are paying a premium to market "day-rates" in order to do so.  Management also notes that, despite the predicted slowdown in offshore drilling and the predicted oversupply of rigs, that they believe they have all their rigs, including those under construction, allocated through 2014 and much of 2015 already.  They have boosted their dividend last quarter, and have repeatedly declared their belief that the dividend is sustainable; but have fairly well indicated they do not expect dividend increases going forward, and have gone so far as to state that they have spun all their growth/risk rig opportunities into the MLP, for which they do expect to grow the dividend going forward.

The bear case is a bunch of analysts pointing at management, thumbing their noses, waggling their fingers, and saying "You're wrong!"  And that the supply glut is more than SDRL estimates, the margins commanded by the newer, shinier rigs are less sustainable than SDRL estimates them to be, and that demand for offshore oil is going to reduce more than SDRL management has predicted.  (I have no idea of the interfungibility of the oil SDRL extracts with the sour shale sands extracts; maybe someone who knows more can hip me to the latest arguments on this topic.)

Awallejr's criticism - that inflation was eating me alive while I sat at the side - struck right to my very heart.  I am all about capital preservation right now.  But SDRL management has stated that the dividend is good for a year, and I think I like their rough-riding Nordic take on affairs - I mean, really, do you see your pump prices dropping right now? - may carry the day.  In fact, I have invested in this thesis with a large proportion of my cash hoard, hoping to collect the dividend for a while and be able to get out with a modest profit for my exposure without suffering capital loss.  I do note that 11% yield suggests the market thinks a large dividend cut is coming, which would likewise reduce the value of capital commensurately; I don't know how much lower the price can go without a dividend cut - what are the naysayers going to do, short these shares through ex-div day?  I doubt it.

The stock is trading at 35.50, just above its 52 week low at 32.40, where Cramer was bullish on it; and well off the highs of 48; Cramer advised folks to get out at 42.  I think that unless management is really selling a bill of goods - which they may well be - or unless there's a rig fire or, heaven forbid, Deepwater Horizon II - the prospects are good.  But I am under no illusions - there's some risk here, and I'm taking the risk because I want to collect this dividend until other investments appear more favorable.

Thoughts, Fools™? 

 

8 Comments – Post Your Own

#1) On May 13, 2014 at 10:32 PM, portefeuille (99.66) wrote:

Longer term charts going back to 2005.



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#2) On May 13, 2014 at 10:55 PM, ikkyu2 (99.14) wrote:

portefeuille thinks I'm smarter than I am; after scratching my head at his charts (thanks!) I eventually learned that SDRL has traded on the Oslo exchange since 2005.  

Rewarded its investors with pretty spectacular returns since then too, unless I have really misinterpreted these charts.

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#3) On May 14, 2014 at 5:06 PM, awallejr (77.67) wrote:

Well I would have suggested a little more diversification.  The whole sector has been under attack.  Barrons, Barclays, CS.  The stock seemed to have settled at $33 and been inching up.  Nuh uh says Barron's, no you don't, we need to knock you down some more before earnings.

Seriously  take a look at the guy's picture shown in the latest article and tell me you would take investment advice from him.  Earnings and a new cc is due come May 20.  So they come out with a scare piece with zero factual support since they need to knock down the price.  They did this to BBEP and they ultimately lost.  They did this to QCOR and they ultimately lost.  And now they are doing this to SDRL.  And there I was on the other side of those plays warning people not to listen to those sharks.

So far the drillers that reported have received increases in dayrates when they were suppose to be declining  So where's the beef Barrons?

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#4) On May 15, 2014 at 1:29 AM, ikkyu2 (99.14) wrote:

I looked at the photo of the dude who wrote that schlocky, zero-data fluff piece yesterday; and the photos of all the Norwegians on the Seadrill board of directors.

I know who I'd back in a fist fight! 

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#5) On May 28, 2014 at 5:18 AM, awallejr (77.67) wrote:

Sweet deal with SDRL/NADL and the Russians. Also nice that they actually increased the dividend to $1 per quarter. So all the naysayers were just plain wrong with this stock.  It is still cheap.  Buy any 2016 $40 and under calls as well as the common.  As has been proven (QCOR, LINE/BBEP now SDRL), CS and Barrons and Barclays were yet again wrong.  The only conclusion I can see is they are simply misleading the retailer for their own agenda.  After all CS did admit to being criminals.

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#6) On May 28, 2014 at 12:13 PM, ikkyu2 (99.14) wrote:

The naysayers are still out in force, awallejr: big article on SeekingAlpha today that boils down to the idea that free cash flow barely supports the dividend and a straight balance sheet analysis.

The article rails against the large amounts of free cash flow used for capex, but then completely ignores - totally ignores - the fact that that money is being used to produce drillships that will then be able to generate revenue.  The analysis proceeds for 3 pages, getting gloomier and more dismal with every sentence, without ever once touching on the idea that if the company has more drillships to lease, it can make more money than it does currently. The author proceeds as if money spent on capex were money flushed down a toilet, and concludes that Seadrill is simply a company that borrows money to pay a dividend.

Seadrill's average rate to borrow money right now is 2.12%.  I am not even sure that borrowing money at that rate to finance a dividend is the wrong thing to do.

By the way, the analysis of risks in the latest Seadrill annual report is one of the best-written, clearest, and up-to-date that I have ever seen in a corporate communication.  It's not boilerplate; it focuses on current data and is clearly explained in plain English.  If these guys are running a scam game as all the analysts seem to believe, they have chosen a very peculiar way to do it.

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#7) On May 28, 2014 at 3:26 PM, awallejr (77.67) wrote:

Yeah I just finished reading it.  I didn't see anything in there that makes SDRL an outright sell like that SA PrudentInvestor was arguing.  You have to remember this was the same guy who railed on LINE/BBEP.

I am making money so I am happy.

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#8) On May 28, 2014 at 4:49 PM, awallejr (77.67) wrote:

Just as a follow up, what bothers me about all the knocks on SDRL's financial condition and ability to cover the divy is that they fail to acknowledge making money through the sale of rigs. From a pure operational point of view if you factor out the deconsolidation of SDLP and the sale of a rig the eps was a miss. And that miss was mainly because 4 rigs were offline for a combined 144 days if I recall correctly.


However there is absolutely nothing wrong with making money off SALES of a rig. That is also part of their business, not strictly leasing. They even told you in their financial release that they plan on trying to buy some quality rigs from distressed owners. That means they could buy it on the cheap then sell it for a profit.

While people generally try to disregard any "one off." Profits off a rig sale is simply not that since it is expected they may continue to profit through a capital gains transactions as well as leasing income.

And this is why the dividend is simply not in jeopardy. They can always make money through sales of rigs to SDLP or NADL. This financial arrangement is BRILLIANT. Why do you think RIG is starting to imitate, because Icahn is no fool and one thing he knows a lot about and that is financing.

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