Seadrill (NYSE:SDRL) stock has been crushed over the last six months as oil prices have fallen. The drop has shown just how risky a drilling company can be, even if they have billions of dollars in contracted backlog.
But the stock's drop also presents an opportunity for investors. Sea drill is still making money and if oil prices rise the stock could shoot higher. That's just one of three reasons I think Seadrill stock could rise.
Oil prices rise
Falling oil prices have single handedly caused Seadrill's stock to plunge and they could single handedly cause it to rise as well. The price of oil will really drive how much leverage drillers like Seadrill have when they begin negotiating offshore drilling contracts in 2015 and 2016. There are more new rigs are coming online, including 16 from Seadrill, and if there's an oversupply in rigs and lower demand, dayrates could plunge. That's what the doomsday scenario the market is pricing in right now.
But if oil prices rise, even to closer to $80 per barrel, we could see contracts pick up, dayrates stay strong, and Seadrill's stock recover quickly. Seadrill did just report $842 million in pro forma consolidated EBITDA for the third quarter, the second best quarter it's ever had. If financial results simply remain flat over the next two years to stock should soar.
Newbuilds get lucrative contracts
Despite low oil prices, some contracts for new, high specification drill rigs are coming in fairly strong. In the third quarter, Petrobras agreed to $2.2 billion worth of contracts for four rigs lasting three years, implying just over $500,000 dayrates. If dayrates stay strong for Seadrill's young fleet the stock could recover, even if oil remains low.
If strong dayrates continue for the 4 new uncontracted ultra-deepwater rigs that are under construction it would maintain strong cash flow, allowing Seadrill to pay down debt or even reintroduce the dividend. Contract coverage for floaters is already at 91% for 2015 and 74% for 2016, so Seadrill only needs a few new contracts to make the next two years far better than the market is expecting.
The balance sheet improves
If you have to point to one reason Seadrill eliminated its dividend after the third quarter it's because of the balance sheet. $13.1 billion of debt as well as nearly $4 billion in yard installments are hanging over the company and it couldn't risk debt markets closing down because it stuck with a $2 billion annual dividend payment.
While that's a negative short term, over the next year Seadrill could pour that money into improving the balance sheet and growing the business. If the two factors I pointed to above play out and the balance sheet improves the stock could double or even triple.
Seadrill had become so tied to a high dividend payout that the elimination of the dividend gives management time to focus on the balance sheet. If it does that, it could build a long-term stalwart in offshore drilling with a strong foundation, not just a lofty dividend.
Travis Hoium manages an account that 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.