Why Seadrill Has More Downside

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Jan 08, 2015

It is reasonable to say that 2014 was nothing short of a nightmare for Seadrill (SDRL, Financial). From 2014 highs of $40 the stock currently trades at $10.38. The big slump in the stock has primarily been due to lower oil prices, suspension of dividend and the company’s leverage.

While the stock has been beaten down significantly, I am still bearish on Seadrill and in my view; investors should avoid the stock even at current levels. This article discusses the big challenges for Seadrill in 2015 that makes the stock unattractive even after the big correction.

The first reason for a bearish view on Seadrill is the fact that oil is trading at below $50 per barrel, and it seems that oil will trade at lower levels for most of 2015. The big negative for Seadrill comes from the point that offshore drilling has a higher break-even than onshore drilling, and no offshore oil and gas project is likely to break even with oil prices around $50 per barrel.

The direct implication is that offshore drilling activity will slump significantly in 2015, and the degree of the slump is still uncertain. However, offshore drilling activity slump is more than just certain. A slump in offshore drilling activity would mean the following for Seadrill –

  • First, day rates for the company’s operating rigs will be significantly lower than 2014 and this will have a big impact on the cash flows.
  • Second, the idle rigs will increase and this will also have a significant impact on the cash flow as well as the EBITDA margin.
  • Third, the contract status for the new rigs for delivery will remain uncertain. While the company’s leverage will increase on delivery of new rigs, the cash flow growth remains uncertain.

Readers might point out that these are not new factors. However, the key difference between talking about these factors one or two month before and now is oil price. At sub-$50 per barrel oil price, these factors will play a big role in producing very depressing quarterly results for Seadrill. The stock will decline as quarterly results are declared that throw more light on the rig status.

Another big worry for Seadrill that will result in stock prices going lower is the debt maturity that is scheduled in 2015. The company has approximately $1.7 billion in debt maturity over the next one year. The main concern is that when this debt is refinanced, the new debt will be at a much higher cost because of a significant increase in overall risk for the company and its debt holders. The cost of debt will increase, and this will increase the cash interest outflow component.

Therefore, on the debt side, the worry is significant as Seadrill also need to fund the new rig deliveries in 2015. The company will need debt to fund the new rig deliveries and the new debt will also come at a higher cost.

One option for Seadrill is to sell some assets. However, selling assets will also be a challenge as difficult market conditions might result in no buyer or buyer at very low prices. Clearly, the trouble for Seadrill is far from over and if oil prices sustain at these levels, the problems will only get bigger.

Therefore, I am of the opinion that investors need to avoid Seadrill and wait for the company’s action on debt coupled with an indication on the kind of contract coverage for 2015. Once these aspects are clear, some exposure to the stock can be considered.