Seadrill Partners (SDLP, Financial), which currently offers cash distribution of $2.27 per share and a distribution yield of 19.5%, is a good investment at current levels. This article discusses the reasons to be positive on the stock. Before taking the discussion forward, I will emphasize, as I have done with all stocks in the energy sector, that investors should consider small exposure to stocks in the sector. The industry outlook still does not point to a big plunge in the sector.
Coming to the first reason to be positive on Seadrill Partners, the company had an order backlog of $5.0 billion with a remaining contract term of 3.0 years. The other backlog is with strong counterparties such as BP (BP, Financial), Exxon (XOM, Financial) and Chevron (CVX, Financial). Therefore, the backlog can be considered as firm.
It is also important to mention that Seadrill (SDRL, Financial) expects offshore market conditions to remain challenging through 2016. Seadrill Partners is well positioned from this perspective with no rig going off-contract in 2016. The company’s rigs will need new contracts only on or after the first quarter of 2017. If industry conditions start improving towards the end of 2016 or in early 2017, Seadrill Partners might find re-contracting of rigs to be relatively easy.
A firm order backlog for all the rigs through 2016 also implies that the company’s revenue, EBITDA and cash flow will remain stable in the coming year. While Seadrill Partners might decide on reducing distribution if industry conditions remain depressed, the company’s credit health will remain strong on the back of robust backlog. Therefore, the stock is trading at attractive levels after correcting by 30% in YTD15.
From a revenue growth perspective, Seadrill Partners recently acquired West Polaris rig from Seadrill and the rig is contracted through March 2018 with an order backlog of $493 million. This implies that the company’s FY16 revenue and cash flow will be higher as compared to FY15.
Seadrill Partners does have debt of $3.6 billion as of 2Q15, but I don’t see that as a concern. Since the company’s rigs will continue to generate solid cash flows, I expect debt servicing to be smooth. Seadrill Partners also has the flexibility to increase its debt for further dropdown from Seadrill in the coming quarters. While debt will increase, the company’s cash flow will also increase through long-term contracts. Therefore, debt is not a concern at least until the first quarter of 2017.
I am mentioning 1Q17 as two of the company’s rigs are going off-contract in 1H17. While I expect market conditions to improve and the rigs to be contracted again, if the market conditions remain challenging, the cash flow will take a hit on rigs remaining un-contracted. However, that risk factor will be discounted in the stock in the latter half of 2016 if market conditions fail to improve.
From an industry perspective, there are several reasons to believe that oil can potentially trend higher from current levels over the next 1 to 1.5 years. First, U.S. oil production has finally started declining. Second, OPEC production declined in August due to disruption in supply from Iraq. Overall, I believe that lower oil prices have translated into lower production and rig investment and this will result in the supply-demand gap narrowing. Therefore, I see oil prices gradually trending higher in FY16 and the offshore industry is likely to have a brighter outlook for FY17.
In conclusion, Seadrill Partners has witnessed correction in FY14 as well as in YTD15. With oil prices bottoming out in all probability, it might be a good time to consider some exposure to the stock with a long-term perspective.
