The worst could be yet to come for offshore drillers like Seadrill. Image source: Seadrill Ltd.
Two years ago, offshore driller Seadrill Ltd. (NYSE: SDRL) was a high-flying investment. Not only did the company have one of the best, newest fleets of ships operating in its industry but a sparkling record for safe and efficient operations, too. Founder John Fredricksen, who was (and remains) the largest shareholder, was renowned in the shipping and offshore industry as a bit of a visionary, and was a driving force behind the company's aggressive growth an expansion. Better yet, oil prices were well over $100, and there seemed to be no end in sight to the opportunity for the company to keep growing.
Then everything changed, and as things stand today, Seadrill isn't a stock that belongs at the top of anyone's "buy now" list. Let's take a closer look at why Seadrill isn't a good stock to buy today, as well as two stocks you'd be better off buying first.
What changed with Seadrill and why now's not a time to buy
Oil prices are down almost two-thirds since June 2014, and the offshore industry is in disarray. Seadrill, once a megadividend stock, pays nothing today, and the share price is down more than 90%. Most importantly, even if oil prices were to double in the next few months, it's likely to take years for the offshore drilling industry to recover from what has become the worst offshore downturn in nearly 30 years.
Could Seadrill recover? Definitely. Between Fredricksen's influence and involvement, and the company's high-quality fleet, chances are probably better than ever that Seadrill will bounce back. But at the end of the day, we're talking about potentially years before this plays out. As things stand now, the offshore drilling industry remains vastly oversupplied with vessels, and even Seadrill's advanced fleet has struggled to find new work for off-contract ships. That's not changing in 2016.
A distributor positioned well for the eventual recovery
The first stock I'd consider over Seadrill is energy equipment and parts supplier NOW Inc. (NYSE: DNOW), the former distribution segment of National Oilwell Varco, which was spun off as a stand-alone company in 2014.
NOW Inc supplies every segment of the oil and gas value chain. Source: NOW
NOW is far from immune to the downturn. Its revenue is off by more than 30%, as oil and gas producers and service companies have slashed their spending on the products that NOW provides. But at the same time, the company is still cash flow positive, and has been able to cut its costs as the downturn has persisted.
NOW Inc also has a strong balance sheet, with $108 million in debt, and minimal capital commitments. It also has access to significant liquidity, with a $750 million line of credit and a $250 million revolver at its disposal. This strong financial position has the company in a fantastic position to take advantage of the downturn and grow, if the right acquisition opportunities come available.
Lastly, NOW will be one of the very first companies to benefit from the eventual oil recovery. Currently, the North American onshore oil rig count is down more than two-thirds from its 2014 peak, and each of those laid-down rigs will require more than $30,000 in parts immediately to come back online, and regular replacement parts as they remain in service.
In other words, NOW could see its prospects (which are far from dire today) pick up within months of an oil price recovery, while Seadrill could still be years away from bouncing back.
A service company that's helped producers make money in the downturn
Core Laboratories, N.V. (NYSE: CLB) is an oil-field service provider, and that's a segment of the industry that has been as hard hit as they come. After all, one of the first things oil producers do when oil prices fall is slash spending. The second thing they do is go to their service companies and demand lower rates.
In other words, a double whammy of less business, and less money for what business there is to get.
Yet Core Lab has managed to remain strong, even if its stock price is down more than 40% from the 2014 high. And that's because the company's business is to help producers identify where the oil and gas is in the ground and to get more of it out at a lower cost -- a critically important service with oil prices sharply down.
Core Lab's business is helping drillers find and produce oil and gas fast and cheap. Image source: Core Lab.
Like NOW Inc., Core Lab doesn't require a tremendous amount of capital expense, and has continued producing steady positive cash flows during the downturn, while more "picks and shovels" companies like Seadrill have much larger capital and operating expenses that continue to weigh on them. Core also has a strong balance sheet, with $431 million in low-cost, long-term debt that its steady cash flows can easily service while still supporting the modest dividend, yielding about 2% at recent prices.
Key industry suppliers today; less at risk tomorrow
The bottom line is a prolonged downturn could prevent NOW Inc. and Core Lab stocks from being market-beating stocks in the near term. But at the same time, these are solid companies with steady demand even at current levels, generating more than sufficient cash flows to support the businesses. The offshore industry, however, is only likely to deteriorate further, meaning Seadrill may not have seen the worst yet. At the same time, they are also much better positioned than Seadrill to get immediate benefit when oil does eventually recover.
Put it all together and it's hard to argue for investing in Seadrill today, when Core Lab and NOW are better positioned, lower risk, and will benefit much more quickly from a recovery.
