The offshore drilling market has been through the ringer in 2014 and no one knows quite what to expect in 2015. The best way to get a peek into the market is listening to the management of companies in the know. That's why Seadrill's (NYSE:SDRL) recent earnings call was a crucial insight for investors. Here are five takeaways from the call.
Operations are great ... for now
"The Seadrill Group has had another strong quarter and has grown EBITDA by 27% year-over-year. I'm pleased with this impressive growth rate and the amount of value we have generated for shareholders by operating a best-in-class fleet with a best-in-class Organization." --Per Wullf, CEO
Operationally, Seadrill is doing quite well despite its stock price. Group EBITDA was the second highest on record at $842 million and contracted backlog was $24 billion.
That's solid past performance, but what has the stock falling is uncertainty about the future of the offshore drilling market. Even Seadrill's management said that activity has been slow and dayrates have fallen, which puts a cloud over the company's future.
Long-term fundamentals remain strong
"The Company believes the long-term fundamentals of our industry remain intact, driven by the fact that the days of easy, low-cost oils are over and reserves required to meet long-term demand growth are still to be found in the deep and ultra-deepwater regions." --Per Wullf, CEO
Contracts activity has slowed recently, but the backdrop in the oil market remains strong. Over half of the new reserves found in the last two years is from deepwater and with costs generally rising for onshore wells the market should move more offshore.
But short term that's not what's playing out. OPEC's decision to keep production steady has caused oversupply in the market and prices have plunged, making even offshore drilling riskier.
If you're going to own shares of Seadrill you have to buy into the thesis that onshore drilling is becoming more expensive and more drilling is going to have to move offshore into deeper and deeper water. That's what Wullf was talking about in the quote above.
Seadrill is fighting against breakeven competitors
"With approximately 25% of the ultra-deepwater fleet available in 2015, certain rig owners seem willing to work at or close to cash flow breakeven rates and we expect this type of activity to continue in the short-term. Seadrill remains very well-positioned in this environment with relatively few rigs exposed to falling day rates in the near-term." --Per Wullf, CEO
Despite the long-term fundamentals of deepwater drilling, short term there's a challenge with oversupply in the market. According to Seadrill, 45% of the floater fleet is over 15 years old and 30% is over 30 years old. These rigs will need to be scrapped eventually, but some owners may be willing to contract at breakeven dayrates, pushing rates for all rigs lower.
As Wullf said, Seadrill doesn't have much exposure to this weakness near term but it's worth keeping an eye on how quickly older rigs are scrapped if the market stays weak because less competition will be good for companies like Seadrill with newer drilling fleets.
The dividend cut was a preemptive move
"Seadrill is prepared for whatever may transpire having blocked a large portion of its fleet and by making a pre-emptive dividend cut in order to pay down debt and focus on opportunities that may arise." --Per Wullf, CEO
When Seadrill reported earnings the stock plunged 23% in large part because it eliminated a generous $4 per year dividend. The move wasn't made because the company will run out of cash soon, but rather because it saw better opportunities with the cash like paying down debt, opportunistically buying rigs, and paying for its own organic expansion.
But the biggest driver may have been capital markets.
Capital markets played into the dividend cut
"We view the deterioration in oil prices as an indicator of more than broad demand growth concerns and must approach the current macro environment with an element of caution. This, taken into account with the near-term oversupply of drilling units, makes it all the more important to build a strong balance sheet. In addition, the financing market has become incrementally worse, and although Seadrill still has significant access to funding, some markets have become unattractive." --Rune Magnus Lundetrae, CFO
This statement pretty much sums up the offshore drilling market and the reason Seadrill cut its dividend. Oil market weakness is making debt markets nervous and less likely to lend to Seadrill at favorable rates, especially considering its $13.1 billion debt load. So, the dividend was cut to bolster the balance sheet, combating some short-term fears and keeping debt markets open.
Some of these factors may be short term in nature but investors need to keep an eye on how supply and demand play out in the next year and how dayrates are affected. But long term, Seadrill's management thinks they're well positioned for the future.
Travis Hoium owns shares of Seadrill. The Motley Fool recommends Seadrill. The Motley Fool owns 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.