Sunday, 02 March 2014 00:00

Seadrill: Credit Perspective For Equity Investors

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Seadrill Limited (NYSE:SDRL) provides offshore drilling services to the oil and gas industry worldwide. The stock is currently trading at $36.96 and offers an attractive dividend yield of 10%.

An important question for equity shareholders is on the sustainability of the dividend. This article investigates Seadrill primarily from a credit perspective to conclude on the growth, cash flow and hence dividend sustainability.

Equity analysis and a stock price target is what investors might be looking forward to reading. However, a credit perspective becomes important for a company with a total debt of $13.5 billion as of December 2013.

The table gives some important financial numbers and credit ratios for Seadrill as of December 2013. A discussion on the implications will follow.


Seadrill Ratio Analysis


Seadrill’s debt is significant, but not a concern. This is possibly the simplest explanation. To elaborate, Seadrill has an EBITDA interest coverage ratio of 8.2x and an operating cash flow interest coverage ratio of 5.0x. In other words, the debt is high, but debt servicing is not a concern as Seadrill is generating sufficiently high cash flows.

Will Seadrill continue to generate sufficiently high cash flows?

A forward looking analysis is important as we are looking at dividend and growth sustainability in 2014 and beyond. There are two important points to discuss here.

First, Seadrill has a strong contract backlog and this ensures revenue and cash flow visibility over the next few years. As of December 2013, Seadrill had a contract backlog of $20.2 billion. This gives the company a revenue visibility of nearly 5 years based on FY13 revenue of $5.3 billion. The important point to mention here is that the company’s order backlog is with strong counterparties such as BP PLC, Total SA, Exxon Mobil, Chevron and ENI among others. This largely ensures that the contract backlog is converted into cash flows. Therefore, the interest coverage will remain high and dividends will keep flowing for equity investors.

Second, As of December 2013, Seadrill has 20 rigs under construction. Total remaining yard instalments for newbuilds is approximately US$6.3 billion and US$1.5 billion has been paid to the yards in pre-delivery instalments. As these new rigs come into operation, incremental revenue growth and cash flow growth is on the cards. While new rigs will further increase the debt, the cash flow will increase accordingly.

The factor of existing contract backlog and expected new contracts makes us believe that Seadrill will continue to grow and it would not be surprising to see dividends increase further in 2014 and 2015.

Before concluding, we would also like to throw some light on the company’s debt maturity schedule as of December 2013.


Seadrill Debt Maturity Schedule 2014


The point we want to make here is that nearly 57% of Seadrill’s debt is maturing on or beyond 2017. In other words, the company does not face any meaningful debt refinancing pressure in the immediate future.

In conclusion, Seadrill looks attractive at current levels of $36.96 considering a healthy dividend yield of 10% and a fair EV/EBITDA valuation of 11.0x. Competitors such as Ensco, Noble corp. and Transocean might be trading at lower EV/EBITDA valuation. However, Seadrill has an advantage in terms of a younger fleet, higher revenue visibility and the highest dividend yield among peers. We therefore conclude that Seadrill is a “Hold” at current levels and will continue to reward investors over the next few years.

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