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When a company's stock falls 95% like Seadrill's (SDRL +0.00%) has over the past couple of years, clearly there are some risks that investors are concerned about. For Seadrill, one of them is out of its control while the other is very much of its own making. Let's take a look at the two risks that have investors spooked at the sight of Seadrill's stock and whether there is a silver lining in this situation.
The two big concerns: Contracts and debt
The decline in oil and gas prices has impacted just about every company in the oil and gas sector, but the impact on Seadrill and other offshore rig companies is a bit unique. As prices for oil and gas drop, exploration and production companies have been apprehensive to spend on new exploration and development projects. Part of that is because their cash flows from operations have shrank and there has been some necessary belt tightening, but these companies have also revised down their long-term oil and gas price projections. In a matter of a year, the integrated major oil and gas companies -- Seadrill's largest clientele base -- have revised their oil price assumptions from the range of $60-$70 per barrel to $50-$60.
Unfortunately for Seadrill, this means a couple of things. One is that many deepwater projects are considered nonviable economically. A great example of this is Royal Dutch Shell's decision to abandon its Arctic drilling program. While the company did find oil, it wasn't enough to justify spending on a project there at today's prices.
The other is that the ones that are considered economically viable are in part because companies like Seadrill are taking lower contract rates and driving down the overall cost of projects. Ultimately, this means that Seadrill is bidding on fewer available jobs and are bidding lower rates on any available projects. All of this is leading to a decline in service rigs and lower profitability as a result. Unless Seadrill can find new contracts, it expects to see three of its rigs go off contract by the end of 2016.
If this was the only issue Seadrill needed to confront, chances are investors wouldn't be quite as bearish on its stock. There ism however, a little issue of a massive debt balance that will become increasingly difficult to support as revenue declines. Today, Seadrill's debt is by for the most burdensome of its peers, and its doesn't nearly have the current assets stored up to pay off its short-term obligations like the others do.
| Company | Net Debt to EBITDA | Total Debt to Capital | Current Ratio |
|---|---|---|---|
|
Seadrill | 5.0x | 51% | 0.71x |
| Transocean | 3.0x | 35% | 1.88x |
| Noble Corp. | 1.6x | 35% | 1.67x |
| Ensco | 1.6x | 38% | 4.36x |
| Diamond Offshore Drilling | 2.3x | 38% | 0.87x |
| Atwood Oceanics | 1.7x | 30% | 5.76x |
Data source: S&P Global Market Intelligence.
These factors together are all coalescing on Seadrill's stock, and that is why shares today are trading at a price to tangible book value of just 0.11 times. Basically, the market is treating these shares as though the company's underlying assets -- after paying off all that debt -- are only worth $0.11 on the dollar they represent on the balance sheet. That is basically a valuation that says this company is headed toward financial ruin.
Are these fears justified?
There is plenty of uncertainty in the market to go around, and Seadrill's balance sheet hasn't looked so hot for a long time. To be fair, though, the company has reduced its total debt load by 39% from its peak in 2013 and has a couple more quarters of generating enough cash to pay down debt before more rigs under contract roll off.
It's hard to imagine, though, that this company is going to completely blow up. Despite all of the challenges it will face in the coming years, it has two things going for it. One is that its founder and chairman, Jon Fredricksen, owns just north of 23% of all shares outstanding and a large chunk of his personal wealth is tied up in the equity of this company. This means that the odds that it will go into bankruptcy protection are much less likely. Chances are, the company will do many things such as sell rigs or other measures before taking any action that would either drastically dilute or completely wipe out existing investors.
The other aspect that Seadrill has going for it is the company's fleet of rigs, which is by far one of the newest and technologically sophisticated fleets out there. This gives its rigs a much longer economic lifespan ahead of them than those of some of its competitors. As older rigs get retired and scrapped, there isn't a very large backlog of new rigs on order anymore to replace them. Eventually, the rig market will turn around. It may take quite a bit of time before it does, but when it does, Seadrill will have one of the best fleets of rigs for customers to pick from.
What a Fool believes
Seadrill has some monumental challenges facing it over the next few years. The lack of new work and its higher-than-average debt load mean that the company is under more pressure than others in the industry. If it can get through this tough time, though, it has the assets on its books that will benefit over the long term. Also, the support of a highly invested founder should give other investors a little extra confidence. This stock certainly isn't for everyone, but for those looking to take a risk on a dirt-cheap stock, Seadrill may be worth a peek.
