Investing in the oil and gas sector has been nothing less than a bloodbath over the past year, and with each passing week, it just doesn't get any better. After trying to bounce back earlier this year, oil prices are down again to about half what they were last summer:
Offshore drillers have been hit especially hard:
Eventually the market will recover, but even the biggest and strongest companies are at rock-bottom prices right now.
With that in mind, let's take a look at Seadrill Ltd. (NYSE:SDRL) and Transocean LTD (NYSE:RIG). These two big names in offshore drilling are similar in fleet size, but different in the makeup of their fleets, debt levels, and the steps their managements have taken so far to deal with the downturn. Is either one worth braving just yet? Wading in early could net market-crushing returns for savvy investors, but it could also leave you sunk.
Which is it for these two? Let's take a closer look.
Fleet a strength or weakness?
Seadrill and Transocean's differences start with their fleets. Seadrill's is very new, with most of its vessels less than 10 years old. Transocean's, however, is getting a little older in the tooth. So far in 2015, the company has already identified 20 vessels it will scrap, and has plans to sell several more. This step, so far, is happening sooner than many in the industry expected, and Transocean is paying the piper, having taken $938 million in writedowns last quarter due to the lost asset value that will result from these steps.
One only has to look at Transocean's recent fleet utilization rates, which have been in the mid-70% to low-80% range for much of this year, to understand why the company is moving to eliminate its least economically viable vessels. Seadrill, on the other hand, consistently reports utilization rates in the mid- to high-90% range and rarely has ships not under contract.
Both companies have a similar number of new vessels scheduled for construction, but Transocean's newbuild program looks much better suited for the current environment. Transocean has only three newbuilds scheduled for delivery by the end of 2016 and all three are already under long-term contract. It has two more scheduled for 2017 -- also already contracted -- four jackups scheduled to be delivered in six-month intervals starting in 2018, and two drillships scheduled in 2019 and 2020. For those not scoring at home, that's 13 total vessels, with all the near-term ones already under contract upon delivery.
Seadrill has 15 newbuilds on order, with 13 scheduled to be delivered before the end of 2016, at a cost of 3.5 billion to finish paying for them. To date, only one of the 13 has a drilling contract in place.
Transocean is in a position to significantly cut its fleet operating expenses (already fell 17% last quarter) by reducing its fleet size, while Seadrill has a potential Sword of Damocles hanging over its head, with operating costs and debt expense set to climb considerably.
Transocean -- even with the much less impressive fleet -- also has the stronger backlog at just under $20 billion, compared to Seadrill's $8.9 billion ($15.5 billion including subsidiaries). The bottom line is, Seadrill management has a lot of work to do before its fleet is really ready to ride out this extended downturn.
Dealing with the debt; managing capital costs
Seadrill has taken on a substantial amount of debt in the process of building up its modern fleet, while Transocean has actually cut its debt over the past few years:
And the chart above doesn't tell the full story. In March, Seadrill announced that it would guarantee more than $2 billion of debt at subsidiary North Atlantic Drilling Ltd. This improved the subsidiary's financial situation, but it further complicates Seadrill's and weakens the benefits of having subsidiaries like NADL and its master limited partnership, Seadrill Partners. Typically, these subs and partnerships help reduce leverage, since the company can sell or "drop down" assets to the sub or partnership and still receive a portion of the income from the assets via distribution rights and investment holdings in the companies.
While this doesn't increase Seadrill's debt costs, it increases the risk it will have a harder time securing financing going forward. Remember those newbuilds? Seadrill will need to come up with $3.5 billion for those ships, or work a deal to delay delivery. At the same time, Seadrill has $1.3 billion in debt maturing by the end of 2016 that it must also deal with.
Don't get me wrong; I'm not saying the situation's hopeless, but investors should understand that these are very real, very material issues that Seadrill management must deal with over the next 17 months.
Putting the pieces together
I'm not convinced that now is a good time to invest in either. Offshore remains weak and uncertain, and it's hard to know what -- and when -- the eventual recovery will look like.
But with that said, if I were investing new money today, Seadrill's newer, more capable fleet just doesn't overcome the risk of all its debt and newbuild obligations. The fact is, almost everything has to go right for Seadrill at this point, while only one or two things going wrong would wreak havoc. Transocean, on the other hand, may have the older fleet, but it's in a position to keep reducing costs at a time when reducing costs matters most, while Seadrill's costs are on track to go higher.
In other words, Transocean looks to be in a much better position to weather a continued downturn. The way things stand today, that's worth a lot more than the high-risk upside of Seadrill. Either way, I remain unconvinced that now is the time to invest in the sector at all.