The decline in energy prices and the subsequent bearishness in the offshore industry have affected all stocks in the drilling services sector. However, Seadrill (SDRL, Financial) and other group companies such as Seadrill Partners (SDLP, Financial) and North Atlantic Drilling (NADL, Financial) have been significantly beaten down on leverage woes. While Seadrill is working toward restructuring, the challenges remain from an industry perspective.
On May 13, Seadrill Partners announced that it had received a contract termination notice from its current operator, ExxonMobil (XOM, Financial), for the contract for the West Capella.
West Capella was contracted through the first quarter of 2017 at a day rate of $627,500. Considering three-quarters of remaining revenue inflow, the decline in backlog is $170 million.
However, Seadrill Partners will receive a payment of approximately $125 million in two equal installments, the first in the second quarter of 2016 and the second in the first quarter of 2017. In addition, the LP will receive any other direct costs incurred as a result of the early termination.
Clearly, the issue is not related to cash flow pertaining to the period of cancellation of contract through the first quarter of 2017. The primary issue is that the high day rate generating rig will be idle; market conditions remain challenging for a contract any time soon. Even if the rig is contracted in the coming quarters, the markets will be disappointed (in all probability) by significantly lower day rates.
ExxonMobil has two other contracts with Seadrill Partners, and West Capella's contract ($615,000 day rate) will be due for renewal in the first quarter of 2017. If current industry conditions persist, I don’t see a contract extension. In the best-case scenario, a contract extension is likely at a lower day rate.
The loss of cash flow from the remaining period of West Capella's contract is not what markets are concerned about. That will largely be compensated, but Seadrill Partners is on course to lose/end a few contracts with lower day rates; beyond 2016, the LP will see significant EBITDA margin compression.
While the current order backlog suggests that Seadrill Partners will clock revenue in excess of $1.0 billion for fiscal years 2016 and 2017, the markets are certainly looking beyond this, and the focus is on the impact on credit metrics as EBITDA contracts and so does the EBITDA cash interest coverage.
Coming to the investment outlook, the near-term perspective would be to stay on the sidelines as the LP unit is likely to witness some correction in the negative news flow. However, it is important to note here that Seadrill is still scheduled to announce the complete restructuring plan, and that can serve as a positive trigger for Seadrill Partners.
With this in perspective, I would wait for more developments in the next one to two months before taking a long-term view on Seadrill Partners.
Disclosure: No positions in the stock.
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