I'll be the first to admit -- I was relatively pleased with Seadrill Ltd.'s (NYSE:SDRL) second-quarter earnings release, at least at first glance. Not only did the company beat earnings estimates pretty soundly, reporting $0.77 earnings per share when analysts were predicting $0.63, but a quick pass at the balance sheet showed total debt fell by $1 billion while cash increased slightly to $918 million.
Factor in the disclosure that the company had delayed delivery of 10 of its newbuilds -- including pushing two high-cost drillships all the way to 2017 -- and I was ready to heap praise on management.
But after letting the earnings release soak in a little and going through Seadrill's updated Fleet Status Report, I realized things aren't as rosy as they first appeared -- especially when factoring in the terrible shape of the offshore market. Let's take a closer look at the earnings report and the key things you need to know going forward.
Reduced debt, high exposure
It's certainly good news that Seadrill reduced its debt load in the quarter, from $10.6 billion at the end of March to $9.5 billion in the just-ended quarter. However, it should be noted that a lot of this debt was shifted to Seadrill Partners via the transfer of the West Polaris and its loan to that company. So while Seadrill got the debt (and interest expense) off its books, the impact of that debt still remains in the Seadrill family.
Yes, the company did pay down some of its revolving debt, and total debt is down $2 billion from the peak. But, as discussed in the next section, debt is only going to increase again as more newbuilds deliver later this year.
Progress on newbuilds, but is it enough?
I won't deny that Seadrill did itself a huge favor in delaying delivery of 10 newbuilds -- especially pushing two of its drillships all the way to 2017. However, the company still has six newbuilds on schedule to deliver this year. We're talking about probably close to $2 billion in final payments, and millions of dollars in operating expenses once those vessels enter service.
Considering that Seadrill ended the second quarter with almost twice as many vessels out of contract as it started with, the last thing it needs right now is another half-dozen ships it can't find work for. This is a serious concern for the company right now.
The release said "discussions were ongoing" with shipbuilders, so it's almost guaranteed the company is working hard to further delay even more vessels. As a Seadrill shareholder, I'm hoping they can get that done.
Balance sheet in decent shape
With the exception of all that debt, of course. One good sign in the quarter was that Seadrill's cash and current assets didn't decline in lockstep with the drop in debt. Actually, cash increased slightly, though total current assets (which include cash, accounts receivable, and other amounts due) did drop slightly while current liabilities went up a little. Overall, though, nothing changed significantly, indicating the company is burning through assets in order to pay down debt.
Considering the deteriorating state of offshore demand, it's a good sign that Seadrill's balance sheet is remaining relatively stable, and that debt is down (even if it is via asset transfer to a subsidiary).
But is the worst still to come?
Frankly, this is my big fear for Seadrill. Yes, the company has made improvements, cutting costs and debt so far this year, but that shouldn't be a surprise since it has a pretty solid backlog of business between now and mid-2016. However, nearly every expert out there -- and essentially all of the executives in the industry -- have been saying for months that 2016 is probably going to be the worst year for offshore drilling.
One of the major concerns is oversupply. There are just too many vessels fighting for a shrinking pie, and so far the rate of older ships being retired is occurring at a much slower pace than anticipated, putting further pressure on day rates. The reality is, until demand/supply balance returns, it's going to be ugly. Yes, Seadrill's high-spec fleet will get it some preference, but as we saw this quarter, even a high-spec fleet is no guarantee.
As of June 30, Seadrill had seven vessels out of work, versus four in the first quarter. That number could more than double to 15 by year-end, based on newbuild obligations and contract expirations. This is not the position Seadrill investors want to be in when the company enters 2016.
Just don't confuse improvement for a turnaround
That's not a judgment on Seadrill or its management, but a stark reminder that the results now are largely tied to contracts awarded when oil prices were much higher. Considering the number of newbuilds still set for 2015 delivery, and seven vessels already out of work, things are probably going to get worse before they get better. In other words, until the entire oil market bounces back and demand for offshore drilling recovers, Seadrill remains very exposed.
The bottom line is this: Seadrill can't turn around until the offshore market does. Unfortunately, there's no telling how long that's going to take.