Seadrill Limited (SDRL) is a stock both growth and income investors have loved to hate recently. The company has leveraged billions of dollars to build out a more modern fleet, while demand has turned soft. The expectation that demand will remain soft for the next couple of years has sent Seadrill's stock -- and that of competitor and industry giant Transocean (RIG -2.69%), along with most of the rest of the industry -- into the toilet:
Despite the recent decline and some very real concerns over that mounting debt and demand softness, there are a couple of key differentiators that separate Seadrill from its competitors. These two overlooked aspects indicate that, while Transocean may not do much more than tread water in coming years, Seadrill should continue growing. Let's take a closer look.
What are the risks and headwinds?
Seadrill has been spending heavily -- actually, leveraging a lot of debt -- in order to grow its fleet of drillships, tenders, and semisubmersibles. In 2009, the company had just over $7.3 billion in long-term debt. As of the 2013 annual report, debt had ballooned to more than $13.4 billion -- almost doubling in less than five years. Simply put, the on-paper risk is that the company is leveraging itself at the wrong time, right when demand is in decline for Seadrill's services.
If this turns out to be the case, the added operational cost to maintain idle ships, plus growing interest expense (increased to $445 million in 2013), could combine to seriously hinder the company's ability to meet its obligations, including that big fat dividend -- almost 12% yield at recent prices -- which is a big part of the draw for many investors. While maybe not crippling the company, seeing the company fail to keep ships working could get income investors selling, and likely crush the stock price even further.
How big is this risk? On paper, it looks pretty scary: According to Rigzone, Seadrill is only operating at a utilization rate of about 60%. But this number is heavily skewed, as 21 of the 63 assets listed are still under construction. Of the remaining, only four are not currently drilling, and of these four, three are en route to assignments, and one is undergoing inspection. In other words, the "real" utilization rate of assets that are in the water is much higher, with 95% of these assets at work as of this writing.
Simply put, while there are some headwinds, and the risk looks pretty scary, Seadrill does an excellent job of keeping its ships working. We'll talk about why shortly, because the why is pretty darn important.
Compared to Transocean
Transocean is a dominant competitor in the offshore arena, with more than 98 rigs listed on Rigzone and showing 65% utilization. But using the same metrics as with Seadrill -- i.e. removing assets still under construction -- we get a more favorable and accurate view. We also see where the weakness in the offshore market will be for the next several years.
Of the 98 assets Transocean has listed on Rigzone, 12 are newbuilds still under construction. So once we remove these, we have 64 of the 86 assets in the water actually drilling, for 74.4% utilization. Why such a big difference between Seadrill and Transocean's "actual" utilization? In a word, specifications.
18 of Transocean's assets are listed as either "ready" or "cold" stacked, meaning that they are currently removed from operation. By stacking these assets, Transocean is able to reduce the operational cost of maintaining them, while still having the ability to add capacity down the road. The long-term challenge is that almost all of these idled ships don't meet the higher specifications that are preferred or required by their customers.
This is two-fold, as it's both about safer ships and about ships that can get at oil deposits that are in deeper water or harsher environments, and that are deeper underground as well. For many of these assets, Transocean will have to invest more money to make them viable again, via upgrades in capability.
Going where the demand is
SDRL Revenue (TTM) data by YCharts
Seadrill's apparent big risk is actually a canny approach to take market share based on where the demand will be going forward. While the overall industry will be soft in coming years, this softness will be largely felt by operators like Transocean with older fleets. Seadrill has a strong track record of getting its ships under contract, and this pattern should continue due to the advanced specifications of its very modern fleet.
According to Seadrill's most recent filing, it already has 97% of 2014 and 65% of 2015 booked for its floating drillships, and 84% and 67% respectively for its semisubmersibles. As new assets hit the water, there is plenty of reason to anticipate that they will already be under contract, or will be very shortly afterwards.
Final thoughts: A better bet for investors
It's fair to expect that Transocean will also get its new assets to work very quickly after construction; but the biggest difference for investors is that Seadrill is positioned for growth, while Transocean is fighting to maintain business. Seadrill has grown revenue and earnings per share 64% and 85% respectively since 2010, while Transocean has seen revenues decline in that period. While the more recent picture is better (revenues have climbed since 2012), Seadrill's smaller, newer fleet just positions it as the investment with stronger upside.
Most importantly, the downside risk, in reality, is not as bad as it looks on paper.
