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Is Seadrill Partners LLC a Buy?

By John Bromels - Jul 11, 2018 at 1:20PM

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Its parent company just emerged from bankruptcy, which may not be a good thing for this offshore rig operator.

When you're considering buying into a company, you have to contemplate a whole host of factors. Has the company been performing well or poorly? Does it have a viable pathway to growth or recovery? Is the company's industry on the rise or on the wane? 

If you're lucky, the bulk of these factors will point in the same direction. If you're unlucky, on the other hand, you end up with something like Seadrill Partners LLC (SDLP). There are so many conflicting factors affecting Seadrill Partners right now that it can be exhausting just to try to keep up with the offshore rig operator. 

Let's look and see if we can make sense of it all and determine whether Seadrill Partners is a buy.

An offshore oil rig in silhouette against a sunset

The offshore oil drilling industry has been punished by the stock market. Is it ripe to outperform? Image source: Getty Images.

An industry recovery...maybe

When oil prices plummeted in 2014, offshore rig industry investors lost their shirts. Offshore drilling -- particularly in deepwater and ultra-deepwater -- is one of the most expensive ways to produce oil. With oil prices down, oil producers were losing money on these drilling rig contracts. So they canceled them or let them expire, and with them went the sector's fortunes. Share prices dropped by as much as 95%, and several companies were bought by competitors, declared bankruptcy, or went out of business altogether. Today, the stocks of those that survived, like Transocean (RIG -5.11%) and Ensco (VAL), are trading more than 70% off their highs. 

Now that oil prices have recovered somewhat -- Brent crude is trading for about $75 per barrel, up from less than $30 per barrel at the beginning of 2016 -- offshore drilling is looking a bit more attractive to oil production companies, especially ones that skimped on capital expenditures during the downturn and now need to find new production to offset declines from existing wells (coughExxonMobil, cough). 

Indeed, shares of Transocean and Ensco are up 25.3% and 21.4%, respectively, for the year. Transocean even managed to post a sequential quarterly revenue increase in Q1! But even if conditions look ripe for an offshore drilling boom, it's important to remember that unforeseen circumstances -- like another oil price drop -- could cause that industry potential to evaporate. Also, oil companies that have just been burned by a prolonged price slump may be more cautious about investing in offshore drilling, and will probably prefer to seek out cheap onshore alternatives when possible. 

That said, things are looking up for the offshore drilling industry in a way they haven't for quite some time, but Seadrill Partners' share price hasn't risen like many of its peers'. That's a point in Seadrill Partners' favor.

The parent trap

Seadrill Partners, though, may not be able to capitalize on the positive industry outlook. That's thanks to its parent company, Seadrill (SDRL).

Seadrill recently emerged from bankruptcy. When it first received court approval for its plan in the spring, its shares "soared." I put that in quotation marks, because even with the 45.3% increase in price over three months, shares were only trading at $0.34 per share at the end of June, a 99.1% loss over the last five years:

SDLP Chart

SDLP data by YCharts.

As you can see, none of these offshore rig companies have been great investments -- or, heck, even good investments -- over the last five years, but Seadrill is at the bottom of the barrel. That's still the case today, even though the "official" share price is currently about $22 per share (this article explains why that's not a good thing for investors).

Part of the reason the company was hit so hard was Seadrill's heavy investment in a new offshore rig fleet at the height of the oil price boom in 2014. The company heavily leveraged its balance sheet to finance the fleet, and when prices tanked, it was left with a boatload of debt, half-finished (and therefore unusable) rigs, and no way to pay for either. 

What it did still have -- and does still have, even post-bankruptcy -- is a 46.6% stake in Seadrill Partners. Plus, as Seadrill Partners' parent company, it shares some management and operational responsibilities with its subsidiary. And that could complicate things for Seadrill Partners down the road.

The big and the small

Here's what Seadrill Partners' website has to say about its strategy: "We also intend to leverage the relationships, expertise and reputation of Seadrill to recontract our fleet under long-term contracts. Seadrill is one of the world's largest international offshore drilling contractors, and we believe Seadrill will be motivated to facilitate our growth because of its significant ownership interest in us."

So, how's that working out for Seadrill Partners? Well, according to its most recent fleet status report, four of its 11-vessel fleet, or 36.4%, are currently uncontracted, well above the same figure for Transocean's (10%) or Ensco's (17%) fleets. Another of Seadrill Partners' contracts expires in July, which would leave nearly half the fleet uncontracted. But the parent company isn't doing any better, with 17 uncontracted vessels out of a 43-vessel fleet (39.5%), plus another nine currently under construction. Seadrill seems likelier to try to get its own fleet under contract before worrying about its smaller partner. 

Of course, Seadrill could also do something like sell its stake in its subsidiary to raise cash or make changes to its structure. Conceivably, it could even absorb Seadrill Partners. The bottom line: We don't know what's likely to happen here because nobody's talking. 

Investor takeaway

Seadrill's not likely to say much of anything until its bankruptcy is further in the rearview mirror. Until then, it's unclear exactly what the plan is going to be -- strategically or operationally -- for Seadrill Partners. One thing is clear, though: With large portions of their fleets uncontracted, both companies are lagging their peers even as the industry may be starting to recover. 

Seadrill Partners' future is just too uncertain to buy into right now (and its parent, of course, has just emerged from bankruptcy, so I'd stay away from it for now as well). If you're interested in other energy partnerships or offshore drillers, though, there are plenty of other fish in the ocean.

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