Seadrill (SDRL +0.00%) and Transocean (RIG +3.73%) have both been hard-hit by oil prices, but their recent earnings release show both companies beating Wall Street expectations. Analyst Nate Wallingsford explains some of what's going on at each company, and how Foolish investors can look beyond the headlines to make informed decisions about these and other offshore drillers.
Meanwhile, the two largest players in solar, SunPower (SPWR +0.00%) and First Solar (FSLR +2.51%), are in "elevated negotiations" to form a YieldCo. If you are as flummoxed as Mark Reeth about what that means, not to worry! Fool's Tyler Crowe explains what a YieldCo is, why the solar companies are discussing it, and whether it's good or bad news for investors.
A full transcript follows the video.
Mark Reeth: Hey everybody, I'm Mark Reeth, here with Tyler Crowe and Nate Wallingsford. Welcome to another edition of Industry Focus.
It's Thursday, which means it's an energy-focused Industry Focus, and it should be a fun one, filled with plenty of patented Tyler Crowe rants. It's going to be great!
Tyler Crowe: I'm a grumpy old man.
Reeth: Yes, you absolutely are! We've got a lot to talk about today, but we're going to kick things off with earnings from both Seadrill and Transocean. Nate, things are not looking too good for these guys.
Nate Wallingsford: Yes. I think a lot of investors were a little nervous before this earnings release, but actually as of right now, they don't look too bad.
Reeth: Oh?
Wallingsford: Yes. Much to the surprise, as I'm sure most analysts and investors were expecting, Seadrill and Transocean both beat Wall Street expectations.
Reeth: Ooh!
Wallingsford: Despite that, shares are still about flat right now, so there haven't been huge jumps that we've see in the past, with the swing in oil prices. Just on this earnings release alone, shares have stayed kind of flat.
We'll get into Seadrill first. It's no surprise that the stock was down 70% over the last eight months; really that hasn't changed, but their earnings gave a positive light on things. The revenue beat expectations about $1.26 billion over a $1.25 estimate. Not a huge beat, but ...
Reeth: We'll still take it.
Wallingsford: Yes, it came in a little better than expected, although this is still down from the quarter prior, Q3, and down from a year ago as well. Still not great news over the long term, but they managed to eke out success in this most recent quarter.
With that, talking about operations a little bit, they were able to secure five new contracts in the quarter. This was a little bit of a surprise because with oil prices being what they are, and the huge crash, management was still able to go out there and secure contracts.
Reeth: Right, and nobody's drilling right now, right?
Wallingsford: Yes, exactly.
Reeth: Why would you, if oil prices are still so low?
Wallingsford: Of course.
Reeth: That is interesting, OK.
Wallingsford: That was a good surprise, and with that they added to their backlog about $1.3 billion along with those contracts, so they're sitting right now at a backlog of about $11.6 billion, which is pretty healthy considering that they cut their dividend completely now -- or eliminated their dividend. That will allow them to have some cash going forward, to finance their operations.
Reeth: Hang on. They completely eliminated their dividend?
Wallingsford: Yes.
Crowe: Yes.
Reeth: I did not know that. That is ...
Crowe: You've really been out of it. They did that last quarter, man!
Reeth: That's a huge warning sign. Wait a minute! People freak out about that.
Crowe: Oh, they did.
Reeth: Okay.
Crowe: Oh, they did. Yes.
Reeth: Okay. I'm just glad I didn't miss that entirely. My god! Okay, sorry. Sorry, keep going.
Crowe: Have you been hibernating on us?
Reeth: You know, I just really don't ...
Crowe: It has been cold here in D.C.
Reeth: It's still snowing.
Crowe: I don't know if you just crawled into your Mark Reeth cave, here at The Fool.
Reeth: A lot of snow, yes. Came out with this wonderful beard, yes. Okay, Nate, keep going. What about Transocean? How are they doing?
Wallingsford: Transocean, pretty much the same story as far as offshore drillers go, down 60% over the last eight months. They cut their dividend by about 80%, so they haven't eliminated it completely, but again 80% ...
Reeth: Not great.
Wallingsford: Yes, it's not looking good. With that, Moody's actually downgraded the credit rating on the company, so they have lost their investment credit rating as of right now, which is not going to bode well for financing future operations in 2015, and maybe even longer than that.
That being said, they did beat Wall Street expectations. Wall Street estimated $2.10 billion in revenue, and actual came in about $2.24 billion.
Reeth: Not bad.
Wallingsford: Yes, a little bit better revenue beat than Seadrill had, but again, same story as Seadrill. This is slightly lower than Q3, down from a year ago period, so not completely shocking news, that they beat.
In terms of the contract backlog, they're sitting pretty well also; $21.2 billion as of just last week, so plenty of projects coming up although they did say that day rates for their drill rigs coming up this year, likely to experience some difficulty with that, just because of what the environment is right now.
Reeth: Understandable. Wait. Wait a minute, do you sense that? Something in the air!
Crowe: Here it comes.
Wallingsford: I smell it.
Reeth: Tyler Crowe. Tyler Crowe has something to say about all of this.
Crowe: All right. I've been building on this lately a lot, and the more and more I see it, the more I don't understand it -- is the concept of consensus earnings estimates.
If you look across these, there's supposed to be a consensus, like everybody is in agreement. However, depending on where you go, consensus estimates always change. If you go to Morningstar it's one thing. If you go to Yahoo! it's another thing, you go to Zacks it's a whole different thing.
What I don't understand, though, is why people even bother making these anymore. If you're making a consensus earnings estimate, what everybody is supposed to agree on, it should basically determine what it's going to do. But if you can't agree on it ...
You go to one news article and it'll say it beat earnings estimates, and then you go the next page and it'll say it missed earnings estimates, or something like that. It just doesn't make any sense.
Pick one. Somebody, please pick one. There should be some ultimate authority on consensus estimates on, "This is the one." If you don't meet it, fine. But stop saying one beat, one the other.
I've got another really great one, every single time -- the dumb story of the day. As we've started to notice more and more and more, there is just really, really dumb things that are written in the financial media landscape.
Reeth: Not from Fool.com, obviously.
Crowe: No, absolutely not.
Reeth: Our dumb things are funny.
Crowe: Yes. We do it in jest.
Reeth: Yes, we do it on purpose.
Crowe: But here was the best thing that I read. It was the advice that you should sell Seadrill because its stock has dropped more than some of its competitors.
Reeth: Hmm!
Crowe: What it basically said was, it argued that since Seadrill is in a worse position than many of its competitors -- one being Diamond Offshore (DO +0.00%), which was the one that they really pointed out -- that you should sell shares in Seadrill because they have dropped more than Diamond.
Now, within the past week alone, this is what has happened. Seadrill has a 94% utilization rate on its rigs. It just secured six new contracts, and actually looks like it's weathering the storm pretty well.
Two days ago, Diamond Offshore announced that five of its contracts were canceled, and its backlog is shrinking, and has been losing money hand over fist. So, just because the stock is going down more you should sell that company, than the one that is just hemorrhaging money?
Reeth: That makes a lot of sense to me. I like it. This is a good teachable moment, by the way. When you are running the numbers, where are you getting your consensus estimates? Who do you believe, so our listeners out there can turn to a trusted source?
Crowe: I really try not to pay attention to consensus estimates in the first place because it's basically a report of what happened last quarter. Basically, somebody threw some numbers in an Excel spreadsheet and said, "Oh yeah, they should do this," and then have their expectations based on that. If they miss, great. If they don't, even worse.
What I'm actually looking for more than anything else, especially when we're looking at a rig company, are the things like what kind of contracts are they bringing online? How many of their rigs are currently being utilized at this point? Are they spending useless money with rigs just sitting in the stockyard, idle, not actually generating any revenue?
Sure, contract revenues have been down for a couple companies, but at least they're keeping the rigs running, which means that they're going to be making money. That's really what I'm going to be looking for, more than anything else.
That was a red flag that I saw with Transocean, was that this past quarter their utilization rate for their ultra, high-specification, brand-new, "Woo, these things are great" -- what are known as the ultra-deepwater rigs -- was only 69% for the quarter, compared to Seadrill that had 94% utilization rate.
It's basically a sign that Seadrill is able to keep its stuff actually employed in a down market, where Transocean is kind of struggling along that front.
Reeth: Good to know, thank you. Thank you for that rant. I've learned a lot, actually, here today from you Tyler Crowe.
Crowe: That's why I do my angry rants.
Reeth: I appreciate it, and so do our listeners, I'm sure.
Moving right along, let's step away from oil real quick because I have a question for Nate. First Solar and SunPower are apparently joining forces and forming something called a YieldCo company?
Wallingsford: Yes, right.
Reeth: I'm confused. What in the world is a YieldCo, and why should I care?
Wallingsford: I'll cue it up a little bit, and then I'll pass it off to Tyler because I think he's ready to dig into this.
Reeth: Oh, he's got a rant?
Crowe: Not an angry rant.
Wallingsford: No, this is going to be good.
Crowe: I'm actually going to do some objective reporting.
Reeth: Okay, so Nate, what is a YieldCo?
Wallingsford: Just to set the scene a little bit; SunPower, First Solar, the two largest players in the solar space, essentially what they said is they've entered into elevated negotiations to form this YieldCo, which means it's probably well on its way.
Essentially what they'll do is take assets for each company's portfolio and house them underneath this YieldCo. It can be compared to what other investors might think of as a REIT or an MLP, in that assets are bundled up under this structure and most of the cash flows that are generated from that are passed down to the investors; the shareholders or unitholders, in the case of an MLP.
Reeth: All right, that makes a little more sense, actually. I like that. Tyler, what's your take on this?
Crowe: Going off of that, why it makes sense for an investor to do this; since basically what they're doing is they're dropping down utility-scale projects, like these large solar farms that we're seeing out in California right now.
These are renewable energy assets, which are able to depreciate their value very, very quickly, thanks to those nice funky tax laws that we have here in the United States; so easy to understand in so many ways!
Reeth: Of course!
Crowe: Basically what they get to do is, they create this odd situation where this holding company or YieldCo essentially generates no earnings because depreciation is so high, so basically it's not taxed because it can say, "Oh, our EBITDA was this, but because depreciation was so high, we have zero earnings," so no taxes.
Reeth: Right. Interesting.
Crowe: However, since depreciation is a non-cash transaction, it gets to have this awesome amount of cash flow that it can immediately transfer to the investor. Therefore, the investor gets a nice high yield on something that isn't taxed twice.
Reeth: Sounds pretty nice.
Crowe: Yes. It's basically, like you said, the same thing as an MLP or a REIT. The nice thing with these YieldCos is they are structured as a traditional C Corp company, meaning that it's a dividend which you pay capital gains on, rather than a distribution that you get from an MLP, which you may have to pay income taxes on.
Reeth: Oh my gosh, I'm already confused.
Crowe: I know.
Reeth: Just tell me, Tyler. As an investor, why would you invest in this YieldCo? Should I be investing in this YieldCo?
Crowe: Well, at least for me, the reason I'd be doing it is because of the dividend. I'm almost exclusively in dividend companies.
Reeth: Nothing wrong with that.
Crowe: It gives you that stability of the return, in an up or down market.
Now, the reason that it makes sense for both First Solar and SunPower, why they would actually want to do this, is they've got these utility-scale projects that generate a revenue stream, a little bit of cash flow, but if you're trying to finance a gigantic utility-scale project, you need hundreds of millions, potentially billions of dollars, to actually get it done.
If you're only getting that incrementally over several years, through the revenue that's generated through this, it doesn't work out as much. You can drop it down, or basically sell it to this YieldCo, get a big lump sum of cash up front.
Maybe keep a little bit of the ownership of it so you still get a little bit of revenue stream, but that big up-front payment is going to allow them to more aggressively pursue these utility-scale projects and keep the balance sheet nice and safe.
Reeth: Then is this a reason to possibly invest in First Solar or SunPower? Does this make them more appealing to you?
Crowe: Well, considering that both companies shot up by like 15-20% after the announcement, I'm assuming that Wall Street liked it very much! It gives them a new way to sell their projects and, what they're saying, is "unlock" the value of them off of their balance sheets.
Being able to drop it down, like we said, allows them to more aggressively pursue these projects, and should help them grow a little bit faster in that particular market of solar, going forward.
Reeth: Very interesting. All right, I'm definitely going to be keeping my eye on that. That is it for us, and this edition of Industry Focus. Tyler Crowe, Nate Wallingsford; guys, thanks for being here.
Wallingsford: Thanks.
Crowe: Thanks for having us.
Reeth: I'm Mark Reeth. Thanks for listening, and we'll see you next time.
