Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



3 Reasons Seadrill Ltd's Stock Could Fall

Offshore drilling rig owner Seadrill (NYSE: SDRL  ) is one of the industry leaders in a growing ultra-deepwater drilling market, but the stock has lagged the market by a wide margin over the past year.

SDRL Total Return Price Chart

SDRL Total Return Price data by YCharts.

One reason for the weak performance is evidence that rig contracting is slowing in 2014. Another is the company's high leverage and dividend yield of 11.1%, which sound warning bells for investors. There's no guarantee that any stock will rise or fall in the future, but here are the three things Seadrill investors should be worried about in the long term.

Big oil cutting back spending

A big factor that has me concerned right now is falling capital spending by big oil companies, who typically drive demand for ultra-deepwater rigs.

ExxonMobil is cutting its capital budget from $40 billion in 2013 to a long-term target of $37 billion from 2015 to 2017. Chevron spent $42 billion a year ago and has budgeted just $39.8 billion for this year. Even Shell's capital spending is expected to plunge from $46 billion in 2013 to $37 billion this year.

Big oil companies are spooked by falling returns on equity and increasing risks for multibillion-dollar projects around the world. If this cautious approach lasts long, it could mean reduced drilling in ultra-deepwater, which would be terrible considering the 73 new ultra-deepwater newbuilds that will be completed in the next three years.

Global energy demand could fall

It seems like energy demand will grow forever, but the truth is that demand for oil has fallen in Europe and the U.S. over the past decade. The higher cost of energy, increasing fuel efficiency, and alternatives to gasoline have created a dynamic that has led to a slow decline of oil.  

European Union Oil Consumption Chart

European Union Oil Consumption data by YCharts.

So far, emerging markets have more than picked up the slack, particularly in China, India, and the Middle East, where growing middle classes are driving more and using far more energy. But if these economies stumble, or efficiency and alternative fuels catch on in emerging markets like they are in the U.S., we could see a rare decline in overall oil demand.

This is the biggest macro risk for Seadrill, because if you think big oil companies are cautious about capital spending now, just imagine how they'll cut back if demand for their end product is in decline.

Seadrill's West Jupiter drillship. Source: Seadrill.

Leverage kills

Hanging over all of these operational risks is the financial leverage management has employed to build out its fleet. At the end of 2013, long-term debt stood at $13.5 billion, which could literally sink the company if the offshore drilling market goes through a major slump. Let's run through an example to show how fast conditions could go south.

In 2013, Seadrill had $5.28 billion in revenue, $3.25 billion in operating expenses, and $445 million in interest expenses on debt. So, operating income minus interest expense was $1.65 billion.

If revenue falls just 10%, and operating expenses and debt costs stay flat, the operating income minus interest expense would fall 33.2% to $1.06 billion. It's this operational and financial leverage that provides a major risk to investors, particularly with large cash outlays for Seadrill's dividend.

Seadrill well positioned but risky

The greatest advantage Seadrill has is its position in offshore drilling with a young fleet heavily focused on the ultra-deepwater market. The downside is that the company is at the whim of customers for demand of its rigs and has a tremendous amount of debt hanging over the company. If operations keep going well, the stock could be a good value, but there are major risks to go along with that potential.

A great way to play the domestic energy boom

You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Read/Post Comments (0) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3086509, ~/Articles/ArticleHandler.aspx, 9/1/2015 4:02:03 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Travis Hoium

Travis Hoium has been writing for since July 2010 and covers the solar industry, renewable energy, and gaming stocks among other things.

Today's Market

updated 6 hours ago Sponsored by:
DOW 16,528.03 -114.98 -0.69%
S&P 500 1,972.18 -16.69 -0.84%
NASD 4,776.51 -51.82 -1.07%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/31/2015 4:03 PM
SDRL $8.04 Up +0.14 +1.77%
Seadrill CAPS Rating: ****