Don't Sweat Seadrill Partners' Earnings Report

Offshore drilling contractor Seadrill Partners (NYSE: SDLP  ) recently announced its first quarter 2014 results. Admittedly, the company's results were likely disappointing to many investors. However, a closer look at these results reveal that they were respectable and show the company's growth story playing out with just a bump or two in the road as Seadrill Partners plows forwards.

Here are the important takeaways from Seadrill Partners' report.

Key figures
Seadrill Partners generated total contract revenues of $260.6 million in the first quarter of 2014. This is lower than the $282.1 million that the company brought in during the fourth quarter. These lower revenues resulted in a slight decline in the company's operating income. In the first quarter, Seadrill Partners reported net operating income of $123.6 million. This compares to $134.4 million in the previous quarter. The company's net income fell much more dramatically, from $113.6 million in the fourth quarter to $43.8 million in the first. Finally, Seadrill Partners increased its per unit distribution by 14%, to $0.5075 per quarter per unit.

Don't worry about the revenue decline
The company's revenue decline is nothing to worry about. This is because it was caused by something that all offshore drilling companies experience: equipment failures on the company's rigs. Offshore drilling rigs are extremely sophisticated pieces of machinery. Like all pieces of machinery, they occasionally break down and need to be repaired.

Two of Seadrill Partners' rigs required maintenance in the first quarter. These two rigs are the West Aquarius and the West Capricorn, both of which are ultra-deepwater rigs. This maintenance work resulted in 60 days of downtime on the West Aquarius and 17 days of downtime on the West Capricorn.

The oil and gas companies that hire these rigs generally don't pay for days that the rig spends out of commission due to downtime. As a result, these two rigs generated less revenue on a quarter-over-quarter basis; this in turn adversely affected the company's overall top line. This is not something that should be a recurring problem, however, as both of these rigs are operational and have been generating solid revenues for Seadrill Partners since the start of the second quarter.

New rig is a growth driver
Seadrill Partners acquired a new offshore drilling rig in the first quarter that was able to somewhat offset the decline in revenues due to repairs on the West Aquarius and West Capricorn. This rig, the West Auriga, was acquired from Seadrill (NYSE: SDRL  ) at the very end of the quarter. As such, it was only able to generate revenues for 11 days during the quarter. This was obviously nowhere near enough to completely replace all of the revenue that was lost due to the combined 77 days of downtime on the other two rigs. However, the West Auriga has a higher dayrate than either the West Aquarius or the West Capricorn.

Rig Dayrate
West Aquarius $540,000
West Capricorn $495,650
West Auriga $565,000

Source: Seadrill Partners, Seadrill

As such, the West Auriga's eleven days of operation was enough to compensate for more than eleven days of downtime on the other rigs, which helped the company's results.

The real benefits of the West Auriga acquisition will come in the second quarter because that will be the first quarter in which the rig operates for the entire quarter. Because the rig generates money each day that it operates, the more days that it operates, the more money it will generate. This will naturally result in growth for Seadrill Partners. The company's management believes that adding this rig to its fleet will generate enough additional cash flow to allow the company to increase its quarterly distribution to $0.54-$0.545 per unit.

Net income fell due to accounting rules, not cash flow weakness
Seadrill Partners' net income fell by much more than can be accounted for by the downtime, but this is not a sign of any weakness in the company's operations. Rather, Seadrill Partners had to take a writedown due to accounting rules.

Like parent company Seadrill, Seadrill Partners uses a variety of interest rate swaps to protect itself from rising interest rates. The company has to do this due to its very high debt load as Seadrill Partners has a debt-to-equity ratio of 1.72. Interest rates today are quite low, enabling the company to carry this debt. However, if interest rates were to rise then Seadrill Partners would see its interest expenses increase significantly when it comes time to roll over this debt. This would hurt the company's cash flow and could potentially jeopardize the distribution.

To prevent this from happening, Seadrill Partners purchases interest rate swaps; these are derivative instruments designed to protect against rising interest rates. During the first quarter, interest rates actually fell, which resulted in Seadrill Partners having to write down $49.2 million to represent the lower value of its portfolio of interest rate swaps. This writedown does not represent any money actually leaving the company, however, as they are unrealized losses. As such, it does not pose as large a problem as it may appear because the cash flow was not affected.

Foolish takeaways
In conclusion, the company's earnings report was nowhere near as bad as it first appears. Instead, it showed a growing company that just had a hiccup and some unrealized losses. Neither of these things had an impact on the company's forward growth, however, and in my opinion Seadrill Partners remains an excellent investment.

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