Seadrill (NYSE:SDRL) has been one of the most hated stocks since the price of oil began to drop, and over the past six months alone, shares are down over 70%. There's a lot of pessimism over the company's future, and some who question its very survival, but for investors taking the long view, there are a few key reasons to buy the stock now. Here are the three biggest reasons to be bullish on this beaten-up stock.
Cash flow, backlog, and flexibility
In 2014, Seadrill generated $3.4 billion in proforma consolidated EBITDA -- a proxy for cash flow from large capital expenditures like drilling rigs -- on $5.0 billion in revenue. For 2015 and 2016, the company and its subsidiaries have $5.0 billion in revenue backlog, which should at least keep the company afloat in the industry's lean times.
On top of the current backlog, Seadrill has this cookie jar of sorts it can dip into called Seadrill Partners (NYSE:SDLP). The company is controlled by Seadrill and will buy rigs with long-term contracts, providing cash for Seadrill when it's needed.
Current conditions in offshore drilling are looking rough, but with a decent backlog, good cash flows, and flexibility to fund operations through tapping subsidiaries put Seadrill in a better position than most competitors.
Cold stacking is a low risk
One of the biggest risks offshore drillers face today is that their rigs will become out of date and unneeded by the industry. According to IHS-ODS Petrodata, 33% of the global jackup fleet and 18% of the floater fleet will be over 35 years old by early 2018, and if the industry continues like it is, they'll be completely out of date. The next step is cold stacking or retiring rigs, which is already happening at a rapid rate.
When a rig is cold stacked or retired, it doesn't generate revenue, and in the case of retirement, never will again. So, keeping your fleet active is key in offshore drilling, and Seadrill is one of the industry's best positioned. You can see in the image on the right that Seadrill has one of the youngest fleets in the industry, both in floaters and jack-ups.
The young fleet means Seadrill will be able to find work more easily than competitors, even if it's for lower dayrates, and large write-downs are less likely. The fleet lowers operating risk that could hurt a lot of other operators.
Upside is tremendous
All investing is about risk and reward. There's no doubt Seadrill stock is high risk, but the upside potential is extremely high as well. Consider that after pulling out the sale of assets in 2014, earnings were still $1.75 billion. With a market cap of $5.5 billion, the company is trading at just over 3 times earnings.
There are risks, like $12.6 billion in debt and $3.5 billion in yard installments due for newly built rigs, but if the offshore drilling market returns to any level of normal, the stock could easily rise 100%, 200%, or more.
That kind of upside doesn't come around often, and when it does, there's always risk attached. I think the risk of oil staying extremely low for more than the next year or two is low, and the upside if oil rises is too much to overlook. That's why I'm holding onto my shares of Seadrill at today's price. It's a high-risk stock, but the potential reward is too much to overlook.