Seadrill Ltd. Earnings: Should Investors Fear a Slowdown?

On Wednesday, Seadrill (SDRL) will release its quarterly report, and investors have been nervous about the state of the deepwater drilling industry for a while now. Joining rivals Transocean (RIG -2.29%) and Ensco (VAL) in suffering share-price declines, Seadrill faces the big question of whether huge day-rates for its rigs can continue as it and industry peers ramp up their production of new equipment to take advantage of the massive profit opportunity.

The rise in oil prices has made deepwater drilling economically viable for oil and gas production companies, and as a result, demand for the deepwater equipment that Seadrill, Transocean, Ensco, and other drillers provide has shot through the roof. In particular, Seadrill's equipment is newer than that of its rivals, giving Seadrill a competitive advantage that it hopes to use to sustain its profitability. Yet recently, moves throughout the industry have called into question whether Seadrill can keep counting on conditions remaining as favorable as they are. Let's take an early look at what's been happening with Seadrill over the past quarter and what we're likely to see in its report.

Source: Seadrill.

Stats on Seadrill

Source: Yahoo! Finance.

Can Seadrill earnings start growing again?
In recent months, analysts have marked down their views on Seadrill earnings, cutting their first-quarter estimates by 15% and reducing full-year 2014 and 2015 projections by roughly 8%. The stock has treaded water, rising less than 2% since late February after a more dramatic drop in January.

Seadrill's fourth-quarter results disappointed growth-hungry investors despite some pretty impressive numbers. Revenue jumped 21% from the year-ago quarter, and net income reversed a year-ago loss with a $281 million profit, helping Seadrill more than double its full-year earnings in 2013 compared to 2012. Yet investors focused on comments that this year and next might see slower growth than Seadrill had expected, worrying that the ultra-deepwater industry might be coming close to reaching its cyclical zenith.

Photo credit: Flickr/L.C.Nøttaasen.

Indeed, the longer-term trouble that faces Seadrill is the prospect that high day-rates could finally start falling. Seadrill believes that exploration companies could start reducing capital expenditures, putting further pressure on the drillship market given the rising sizes of available fleets. Seadrill has an advantage over Transocean, Ensco, and other competitors because its fleet is much newer than those of its peers, and customers want the upgrades that newer equipment offers in order to get their money's worth from high day-rates. That's one reason why Seadrill has been able to attract new contracts even as conditions in the industry deteriorate.

Moreover, we've recently seen some signs that the industry might not be in as bad shape as some had feared. Transocean reported its first-quarter results earlier this month, and its fleet utilization rate actually improved by three percentage points during the quarter. Transocean also validated Seadrill's strategy of using spinoffs to boost yield and control risk by mimicking the approach that Seadrill has long followed.

In the Seadrill earnings report, watch to see whether the company again comments on the threat of oversupply in drilling unit counts. If Ensco, Transocean, and other rivals keep building new units, then even Seadrill's newer fleet could suffer some of the consequences in the long run.

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