Seadrill Ltd. (NYSE:SDRL) on Thursday released fourth-quarter financial results that showed progress on multiple fronts. The highlights:
- Revenue of $1.26 billion, slightly better than analysts expected.
- Long-term debt and total interest-bearing debt decreased in the quarter.
- Cash and equivalents increased sequentially.
- Economic utilization rates remained very high: 93% for floaters and 98% for jackups.
While revenue was down from the year-ago quarter, it appears -- though it's very early in the game -- the offshore driller has already begun making some progress on reducing its debt, and strengthening its cash position . However, the most challenging days for the industry are likely still ahead. Let's take a closer look at the details that matter.
Debt reduction via dropping down assets
Seadrill reduced its total net interest-bearing debt by almost $1 billion in the quarter, but not by paying it off. From the earnings release:
The decrease [in net debt] was primarily due to the derecognition of the West Vela facility following the sale to Seadrill Partners, decrease in related party debt as a result of the West Polaris acquisition, and increase of cash balance.
While it can make reading and understanding the company's financial filings a challenge, this is largely the reason Seadrill has so many related parties and subsidiaries such as Seadrill Partners. By selling assets to subsidiaries it creates to operate either specific kinds of vessels or in certain geographies, the company can secure financing for other newbuilds and reduce its direct debt.
However, if the offshore drilling market further deteriorates amid depressed oil prices, this strategy will be much less effective, as it requires the subsidiary to secure financing for the vessel it is acquiring. If capital markets freeze up for offshore drillers, then it could become much more challenging for Seadrill to deleverage using asset drop-down methods.
Furthermore, every asset dropped to a subsidiary reduces the direct earnings benefit the vessel would contribute if wholly owned by Seadrill.
Current portion of debt and addressing the newbuild "problem"
The Seadrill earnings preview addressed a potential risk the company faces toward the end of 2015, when it has more than one dozen newbuilds scheduled for delivery. The company has already begun negotiations with shipyards to delay newbuilds, and to position itself to not take delivery of new vessels until they are under contract. From the earnings release:
Preliminary steps to delay deliveries have been taken in order to avoid taking delivery of a unit without a contract. For example, agreements have been reached with both Cosco and Dalian to delay delivery of the Sevan Developer and eight Jack-up units. In the case of the Sevan Developer, delivery was initially delayed by 12 months with cancellation options at 6 month intervals with the potential to delay delivery by up to 36 months. The agreement with Dalian extends delivery on eight Jack-up units for a total of 44 months.
That's a significant step in the right direction, but Seadrill still has four ultra-deepwater drillships set for delivery by the end of the year. If the company can secure contracts for these vessels, or reach an agreement with the two shipyards building them to delay acceptance, that would essentially remove the risk of taking any new vessels without a contract. As things stand, the company will need $4.3 billion in either cash or debt to pay for all the newbuilds on order. Probably close to half of that is tied to the four ultra-deepwater ships that is is still obligated to accept this year.
Seadrill's current liabilities -- largely debt due over the next 12 months -- increased by $965 million from the third quarter, largely due to $2.3 billion in long-term debt being due in the coming year, versus $1.7 billion last quarter. The company is seemingly already taking steps to address this debt, either through paying it down, refinancing, further asset dropdowns, or, more likely, some combination of the three.
While some concern remains about how firm the company's order backlog really is after the recent removal of $1.1 billion related to a contract with Petrobras that was never finalized, the bigger concern is that the total backlog declined by $3 billion sequentially to $17 billion. The elephant in the room on backlog? A $4.1 billion deal with Russian oil and gas giant Rosneft, scheduled to close in May 2015. The thing is, either party can cancel the agreement before it closes. From the earnings release (emphasis mine):
Due to recent developments and events, [Seadrill subsidiary] North Atlantic Drilling believes that it will be very challenging to close the transactions on the same terms or in the timeframe contemplated in the executed agreements. Hence there are significant risks attached to the US$4.1 billion order back-log related to the drilling contracts with Rosneft.
In short, there is a significant amount of risk and exposure on the backlog, which could put as many as five Seadrill vessels out of contract in coming months. Furthermore, it sounds like if Seadrill is able to salvage the deal, it will be at less attractive dayrates. This bears watching closely.
While the company is clearly making progress on deleveraging, don't think for a minute Seadrill is sailing clear of the rough seas. Things are going to get rougher this year, and perhaps beyond, as the company's contracts with producers near expiration. If oil prices and demand don't begin recovering, the lack of demand for offshore drilling will get worse, and that will increase the already growing downward pressure on dayrates.
Will Seadrill's efforts pay off in the long run? The company has apparently made a decent start, but I think the hardest days could be coming.