Even when we're not writing about stocks, we're probably discussing some investment theme or stock that perks our interest. Here's a sneak peek at some of the conversations that go on behind the scenes with some of our writers here at The Motley Fool.
After many months, offshore driller Seadrill Ltd. (SDRL) recently completed its bankruptcy reorganization, and reemerged as a new publicly traded company. Existing common shareholders were left with 1.9% of the new Seadrill, wiping out billions of dollars in wealth over the past several years. And while many of us can commiserate over having shared in those losses, understanding Seadrill's future prospects is a better use of time today.
Matt, Tyler, and I (Jason this week) spent some time in our long-running Slack chat discussing the company's prospects going forward, and -- as per usual -- all came to slightly different conclusions. Yet there was one common thread all three of us noted: Until the company provides updated financials, there's too much guesswork involved, and that adds risk.
Image source: Getty Images.
Without better information...
Tyler Crowe: In the absence of Seadrill's financials, there is at least one piece of information we can look over in the interim: its fleet status report. This is a report offshore rig companies issue about as frequently as its quarterly earnings and lets you know what is going on with every one of the company's rigs. Unfortunately, the information on Seadrill's fleet status report paints a picture of a long and arduous recovery.
As it stands, Seadrill has 17 inactive rigs and an additional nine under construction without a contract waiting for it. Furthermore, only eight of its 60 rigs have contracts in place that extend beyond 2020. This means that over the next two years, it needs to find new contracts for almost its entire fleet. That is going to keep Seadrill's marketing team awfully busy.
What makes the situation even more challenging is that Seadrill isn't the only one in this position. Every other rig owner out there is going to have significant contract turnover these next few years and there is a lot of available rigs. This means competition for new contracts is going to be incredibly fierce and the rates for new contracts are likely going to be considerably less than what we saw before the oil price crash. The positive is that drilling activity is picking back up again, so getting those already active rigs new contracts won't be as challenging. Getting those rigs new contracts with favorable rates and additional work for idle rigs, though, will still be hard.
It's going to take a long, long time before we see some of the lucrative rig contracts that companies signed from 2012-2014. Offshore drilling works at a much slower pace than shale, so we might not see a significant uptick in earnings from Seadrill for some time. Depending on what the financials for this company say, though, it's entirely possible that shares are trading at such a steep discount to book value that it might be worth taking a flyer on this stock.
This is where the money is
Matt DiLallo: Seadrill appears to be trading at a deep discount to the value of its assets, which might make it a good value stock to buy. However, as Tyler pointed out, a significant portion of its fleet remains without a contract, which is an industrywide problem. That's because oil companies have shifted their attention on shore since they not only earn higher returns from shale wells but see that payout in a matter of months as opposed to the several years it takes before an offshore well produces a drop of oil.
This shift has the industry poised to pour more than $300 billion into the Permian Basin alone over the next five years to drill an estimated 41,000 new wells, according to a new report from IHS Markit. That investment will boost the region's output up to 5.4 million barrels of oil per day, more than double its current rate. That puts the Permian on pace to deliver 60% of the world's net oil production growth over the next five years.
Contrast that outlook with the one for offshore drilling. After steadily falling for several years, investment spending is finally expected to bottom out this year about 50% below its peak in 2014. From there, it should stage a steady recovery through 2022, according to a forecast by Rystad Energy. However, even with that expansion, Rystad expects 2022's spending to be about 25% below the peak, which could keep the pressure on offshore drilling rates, especially with all the new rigs still under construction that don't have contracts.
When I look at these two forecasts, it's clear to me that the bigger payoff will be in the Permian. That's why I have no interest in buying Seadrill no matter how cheap it might be these days.
Seadrill is cheap by the one metric we can't trust (yet)
Jason Hall: Seadrill emerged from bankruptcy with about half as much debt as it had, while also converting a massive $1 billion in newbuild obligations into equity in the company. At the same time, it also emerged from bankruptcy with $2.1 billion in cash, and none of its debt is due before 2022. It also has $2.3 billion in contracted agreements on its backlog, providing it some near-term certainty for cash inflows. Add it together and Seadrill now has one of the strongest balance sheets among offshore drillers.
It also still has a highly capable fleet made up of some of the newest rigs operating offshore, and a solid reputation as a dependable partner for the major oil and gas producers that operate offshore assets.
And while Matt and Tyler make very good points about the large number of vessels available for work and the explosion of onshore oil investment, I think they should both acknowledge that offshore oil will play a substantial role in meeting global energy needs over the next decade. After all, Matt recently raised the flag on the historically low levels of new resource development during the recent downturn. And while shale will play a role in meeting global demand, it isn't going to replace offshore oil.
Offshore projects are expensive and time-consuming to bring on line. But when they come on, they produce a lot of very cheap oil and gas. And after years of underinvestment, it's going to take substantial spending across every resource -- traditional land-based, shale, and offshore -- to support global demand growth. And that should bode well for Seadrill's long-term prospects, particularly with its strong balance sheet and excellent fleet and history as a safe operator.
But here's why investors shouldn't just blindly assume that means success as an investment. From a recent Seadrill press release:
From the Effective Date [July 2], the Company expects to adopt fresh-start reporting. Under fresh-start reporting, the Company's assets and liabilities are remeasured using fair value accounting principles. Estimates of fair value adopted under fresh-start reporting represent the Company's best current estimates based upon appraisals and valuations.
In accordance with our reporting obligations, the Company will issue its next earnings report in November 2018 which will include half year and third quarter 2018 results and reflect fresh start reporting.
Translation: The prior book value of all Seadrill's assets has been tossed and they will be revalued. This almost certainly means a reduction in the book value of many of its drilling vessels, particularly those that are idle and will require substantial capital spending to bring back in operation. And frankly, it's just too hard to estimate how much the company is really worth.
I could be passing up Seadrill at a substantial discount because of that. But I'm far more comfortable missing out on a cheap stock than buying what in hindsight may be a value trap.
