In the last eight months, Seadrill (SDRL, Financial) has been sideways to lower as offshore industry conditions remain challenging and the company continues to struggle to reduce debt.
Seadrill expects industry conditions to remain challenging through 2017, and this is the general consensus for the offshore industry. Therefore, I don’t recommend a big plunge in the stock, but some exposure at deep value levels can generate robust returns.
It is important to note here that Seadrill has been beaten down in the last two years primarily because of excess leverage, and anything to do with debt restructuring will take the stock higher. Seadrill mentioned in its conference call that the company is in advanced stages of discussion for potential debt restructuring. Once this debt restructuring happens and debt maturity is delayed coupled with relaxation of key covenants, I expect Seadrill to move higher.
For offshore drillers, another important factor is the current order backlog that will help companies survive the next 12 to 15 months even if industry conditions remain challenging. Seadrill has a decent order backlog of $1.8 billion for fiscal 2017, and this will ensure that the company does not face issues related to debt servicing.
The company has been awarded several short-term contracts recently. If this trend continues, I expect the company’s revenue visibility to swell further for fiscal 2017. With the company being active in the spot markets, I expect small order flows to keep supporting the current cash buffer of $1.3 billion.
At the same time, Seadrill has been working toward reducing operating cost and the company expects reduction in costs even for fiscal 2017. While relatively lower day rates will compress EBITDA margin, it is likely to be offset to some extent by cost reduction.
In the foreseeable future, oil price upside is another factor that is likely to be positive for the offshore drilling sector. It seems likely that OPEC is heading for a production cut; if this happens, I expect oil to move comfortably above $50 per barrel.
I must mention here that the dollar has also contributed to weakness in oil price, and the dollar upside is overdone in the near term. With policy uncertainty as Donald Trump assumes power, I expect some economic weakness in the next three to six months that will be negative for the dollar and positive for commodities.
Coming back to company-specific factors, Seadrill has also planned not to take new rig delivery in 2017 without suitable contracts. This is positive from the perspective that new rig delivery will result in increased debt; if the rig is not contracted, there will be no corresponding increase in cash flows. While this would need further negotiation with yards, I expect a positive outcome on this front.
From a liquidity buffer perspective, Seadrill has $1.3 billion in cash and equivalents as of the third quarter, and the company reported operating cash flow of $840 million for the first nine months of the year. I do expect OCF to decline in fiscal 2017 but will continue to add to the company’s cash buffer.
Seadrill might be in one of the worst times from a company fundamental perspective, but the story is far from over for the offshore driller. Once there is news on debt restructuring and oil upside provides support, Seadrill can surge higher and provide strong returns in a short time frame.
Disclosure: No positions in the stock.
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