Analysts Debate: Is SeaDrill a Top Stock?

At The Motley Fool we're built around a motley crew of analysts bringing diverse backgrounds to our stock analysis. Our opinions often differ as a result -- and that's the point.

In a search for the best investment ideas, Fools Travis Hoium, Alex Planes, and Sean Williams have embarked on a journey to discover, debate, and pick the best stocks on the market. In this series we will debate the merits of a stock and, if there's enough conviction in the group, we will give an outperform or underperform CAPScall on My CAPS. After all, being accountable for our stock picks is what makes The Motley Fool different.

Today we debate the merits of SeaDrill (NYSE: SDRL  ) .

Who is SeaDrill?
SeaDrill is an offshore drilling company that owns drilling rigs and generates revenue by leasing these rigs to oil & gas explorers.

Revenue (ttm) $4,192 million
Net income (ttm) $1,506 million
Dividend $3.20, 8.4%
Prized Assets

62 Total Rigs, including:

7 Drillships

12 Semi-submersibles

21 Jack-ups

Competition Transocean (NYSE: RIG  ) , Noble (NYSE: NE  ) , Ocean Rig (Nasdaq: ORIG  )

Source: Company website.

Travis Hoium: In the drilling space, what investors really need to look at is where demand is trending. The clear trend today is that ultra-deepwater is where the future of drilling is, and SeaDrill has the best exposure in the industry. Hercules Offshore (Nasdaq: HERO  ) has repeatedly proven that shallow water isn't the profitable endeavor it used to be and most of the industry's investment is going into ultra-deepwater rigs.

The trend I like is that SeaDrill benefits from the rising price of oil, because demand for offshore rigs is correlated with oil prices. The company recently secured a contract for one of its drillships at a $595,000 dayrate, and these kind of rates should continue with the ultra-deepwater market short on supply for at least the next few years.

A dividend of 8.3% and net debt of $10 billion would usually scare me off, but in this case I can live with the leverage because I think this market will be stable for years to come.

Alex Planes: The twin trends of rising global oil use and a lack of new conventional sources will be powerful actors on exploration companies. It's hard for me to imagine a scenario where oil ever consistently stays below $100 a barrel again (save for a catastrophic recession), and deepwater drilling has been growing tremendously in recent years. A 2010 report noted that global deepwater oil production tripled since 2000, and could potentially exceed 10 million barrels daily in the near future.

Of course, there are risks, as the Deepwater Horizon incident clearly demonstrated. SeaDrill also carries a lot of debt, as Travis mentioned, but its fleet is quite young, with the majority of its rigs (including all but one ultra-deepwater drillship) less than ten years old. That baby-rig boom, so to speak, goes a long way towards explaining the company's huge debt load and deeply negative free cash flow in recent years. As new rigs come online -- 14 are slated for completion by the end of 2013 -- SeaDrill should be able to start paying that debt down quickly.

Most major actors on the global oil market would be just as dangerous to the broader economy as they would be to SeaDrill, so there's little reason to single out one company for that. High leverage is something to watch, but I see many more reasons to buy than to stay away for investors with long-term timelines.

Sean Williams: SeaDrill could have a bright future ahead … if it can just convince me of its present. In a sector where growth can be had by the bushel with oil cresting at $100 per barrel, I have a hard time trusting a deepwater driller that has managed only three positive cash-flow quarters out of the past 24!

It wouldn't be too bad if we we're looking at SeaDrill as a potential value pick that had lost value over the past year -- but we're not! SeaDrill has actually added 19% to its value over the past year, despite boasting a back-breaking $10.4 billion in debt and recently posting a fourth-quarter report gushing with one-time losses.

Then there's what I deem a poor use of capital. It's fantastic that SeaDrill pays out an 8% yield, but why on earth is it giving away its operational cash in the form of a dividend when it's still predominantly on a spending spree and consistently cash flow negative? Considering that Transocean is cheaper across many value metrics and is cash flow positive, I'm passing on SeaDrill here until the company proves to be more prudent with its cash.

The Call
SeaDrill isn't the only operator in the ultra-deepwater space, with Transocean, Noble, and Ocean Rig all expanding their fleets quickly. The reason we've focused on SeaDrill over the others is their relatively young fleet of rigs and the fact that they have less exposure to shallow-water rigs than do Transocean and Noble. Plus, the company isn't run by George Economou, who has a history of destroying shareholder value and may do it again at Ocean Rig.

With Sean's major concerns in mind, we've decided to make an outperform CAPScall on our brand-new TMFYoungGuns CAPS profile. We'll keep a close eye on future cash flow to make sure SeaDrill can live up to its debt obligations, and we'll have one hand on the eject button in case the price of oil takes a dive.

We'll be back next week with another stock pick, but in the meantime, check out the one stock our analysts think is the single best stock of 2012. The report is free -- all you need to do is click here.

Fool contributor Travis Hoium manages an account that owns shares of SeaDrill. Neither Alex Planes nor Sean Williams hold a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, Sean at @TMFUltraLong, and Alex at @TMFBiggles.

The Motley Fool owns shares of Transocean. Motley Fool newsletter services have recommended buying shares of SeaDrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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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.

  • Report this Comment On March 19, 2012, at 11:41 AM, artmuseum wrote:

    This fool of a portfolio manager believes = no analysis of SDRL is complete without mentioning its charismatic Chairman + principal shareholder John Fredriksen =

    who incidentally has outperformed Warren B's Berkshire in the last one + ten years, based on info I got from Yahoo finance charts.

    He is SDRL's rich Daddy, whose billions

    1. ensure lowest borrowing costs

    2. testify to his financial engineering genius.

    Also note while RIG is being "crucified" in Brazil, JF managed to make SDRL going "native" + via sub has optimum relationships in a key market.

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