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Seadrill: Buy On A Pullback To $30

April 07, 2012 | About:

With oil and gas prices staying at record levels, oil and gas companies also experienced record level profits. An alternative to cashing in on this trend is to buy the stock of companies working for these cash-rich clients. In this article I explore one such company, Seadrill Limited (NYSE:SDRL). Seadrill can be used as a hedge against high oil prices while getting better dividend yield than some oil producers.

Seadrill Limited is primarily an offshore drilling contractor providing services to the oil and gas industry worldwide. It offers platform drilling, well intervention, and other engineering services. The company operates a fleet of 62 units that comprises drillships, jack-up rigs, semi-submersible rigs and tender rigs for operations in shallow to ultra-deepwater areas in harsh environment and benign environments. Seadrill has about 14 rigs in the pipeline that can fill up its future growth prospects.

Industry outlook for offshore drilling is good. The continuing high oil prices will continue to drive demand because of oil exploration companies and developing nations looking for sources closer to their shores. Seadrill is well placed in this situation with its expertise in ultra deepwater drilling. Natural barriers to entry to this industry is high due to high capital needed, the time its takes to build a drill rig, and hard to find skilled personnel.

Seadrill has better than average utilization rate and day rate. It was even rumored that it declined $500k a day contracts in expectation of even higher offers. Prospects are good it can get them since reports say that supply of deepwater rigs for 2012 and 2013 is getting tight.

Seadrill’s core advantage has been its expertise in ultra deepwater drilling and its premium rigs for the jack-up market, allowing it to post a much higher gross margin of 61%, compared to the leading players in the industry, like Ensco Plc (NYSE:ESV) at 48%, Noble (NYSE:NE) at 42%, and Transocean (NYSE:RIG) at 24%, and ultimately better net margins.


Seadrill’s appears reasonable with its recent price to earnings ratio at 12.58 and 5-yr expected PEG of 0.39 (supplied by Thomson Reuters). This looks cheap compared to competitors Ensco, Noble Corp., and Transocean, which all have inferior price to earnings ratio and PEG. On the other hand, value is around $25 on dividends alone based on dividend growth model. Stock appreciation prospects add further to value since payout ratio is less than 20%, which overall could go as much as $50.

The bottom line

The recommended strategy for Seadrill is to buy on a pullback to $30, and then hold for 2 to 3 years before exiting. At $30, that would be at price to earnings of 10. 2 to 3 years would be a safe estimate for a time frame that Seadrill can hold its competitive advantage, and that oil price would remain high.

Rating: 4.0/5 (2 votes)


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