Seadrill (SDRL, Financial) is among the worst hit offshore drilling stocks with a massive decline of 84% in the last year.
Leverage has been one of the major concerns for Seadrill besides the investment backlog that requires continued financing in challenging times. However, the stock has been beaten down significantly in the near term and is likely to trend higher in the foreseeable future. My view is further backed by the company’s 4Q15 results where the company beat profit estimates.
For 4Q15, Seadrill reported revenue and EBITDA of $959 million and $513 million with the company’s fleet achieving 93% economic utilization. While the results were down on a quarter-over-quarter basis, the EBITDA margin remains robust, and the focus will be on cash flow generation in the midst of a slimming order book.
Look at the balance sheet and the year-on-year change in debt. For December 2015, Seadrill reported total debt of $11 billion as compared to December 2014 debt of $12.8 billion. For the same period, the company’s cash and equivalents were $1 billion as compared to $831 million for the prior-year period.
Therefore, Seadrill has successfully reduced debt by $1.8 billion while improving the overall cash position. This has been achieved through operating cash flows and sale of business ($1.2 billion according to the company cash flow). Clearly, Seadrill is on a deleveraging path, and this is a credit positive with challenging industry conditions.
For 2016, Seadrill also has $1.5 billion in debt refinancing. It would be interesting to see if the company goes forward with refinancing the debt or the debt is repaid through internal cash flows and asset sales. While debt refinancing might still not be a big challenge, cost of debt to can be expected to increase in the current market environment. Therefore, if cash buffer permits, debt repayment would be a good option.
From potential cash flows in 2016, Seadrill was well-positioned to pay a large part of the debt. However, one of the concerns for Seadrill is that the company still has significant new rig commitments, and the capital expenditure for 2016 is $1.25 billion. If the debt has to be repaid along with capital expenditure through internal cash flows, Seadrill would need $2.8 billion in cash over the next 12 months. I see that coming only through asset sale or potential drop-down of assets to Seadrill Partners (SDLP, Financial).
In terms of guidance, Seadrill expects EBITDA for 1Q16 at $450 million. While this is lower than 4Q15 EBITDA of $513 million, this is largely expected through 2016. Lower EBITDA and EBITDA margin compression will be common for all offshore drilling companies through 2016. However, the key point is that Seadrill will still be able to service debt. If offshore industry conditions remain weak into 2017, the challenges might increase significantly.
Seadrill has reported a good set of numbers (considering current industry conditions) for 4Q15, and I expect the beaten down stock to rally in the foreseeable future. The company expects to talk more on the financing plans in the first half of 2016, and investors need to closely watch how Seadrill manages to reduce debt and navigate the crisis.
Disclosure: No positions in the stock.
