The energy sector as a whole continues to benefit from global economic recovery, particularly as hydraulic fracturing (aka “fracking”) and horizontal drilling techniques proliferate and as oil and gas production moves into ever-deeper ocean waters.
To be sure, flagging growth in Europe and Japan, combined with soaring energy production in North America, have caused oil prices over the last three months to plummet from $100 per barrel to below $80.
However, while this dynamic is bad news over the short term for smaller energy producers with razor thin profit margins, it’s good news over the long haul for Bermuda-based behemoth Seadrill (SDRL).
But first, Seadrill needs to get past its current rough patch.
SDRL Stock Sunk on Earnings
On November 26, Seadrill posted disappointing third-quarter 2014 earnings per share (EPS) of 31 cents on revenue of $1.29 billion, compared to EPS of 60 cents on revenue of $1.28 billion in the same period a year ago. These results missed the consensus estimate of 67 cents in EPS on revenue of $1.23 billion. The company also cut its annual dividend from $4 per share to zero.
Predictably, investors had a panic attack and SDRL got clobbered. As of this writing, the stock is down roughly 30% in the past week alone. But therein lies a contrarian opportunity for investors with patience and a shrewd eye on the horizon.
With a market cap of $7 billion, Seadrill is a leading international offshore drilling contractor, with a vast global presence. SDRL has an order backlog of about $20 billion, which means the company is positioned to prosper when oil prices recover. In the meantime, smaller companies are likely to get shaken out, opening a wider competitive field and driving Seadrill stock.
By cutting the dividend, management is clearly keeping its powder dry. Seadrill is playing the long game by bolstering its balance sheet until oil prices bounce back. With 90% of its “floater” rig capacity booked under contract and major new deals in the pipeline, the company faces a more sanguine 2015.
OPEC last week was unsuccessful in reducing output to bolster oil prices, but economic growth remains strong in the United States, and the push for deepwater drilling is a secular trend that won’t end anytime soon.
Competitors such as Transocean (RIG) also are facing rough waters, but they’re smaller and in a weaker position than Seadrill to capitalize on opportunities when global growth and a more assertive OPEC send oil prices back on their upward trajectory. SDRL has been signing up new business that will soon come to fruition. These lucrative contracts, combined with a stronger balance sheet and a robust order backlog, give the company a formidable war chest for the coming months.
Notably, Seadrill inked a two-year contract in the third quarter worth roughly $497 million with ExxonMobil (XOM) for employment of Seadrill’s ultra-deepwater drilling ship the West Saturn. Seadrill also secured confirmation from Petrobras (PBR) for drilling contracts in massive oil basins in Brazil, with a total revenue potential for Seadrill of $1.1 billion.
Cheap Valuation, Rosy Future
Drilling projects around the globe will keep Seadrill busy, especially as shallower and easier to tap oil resources dry up. Moreover, chronic tensions in the Middle East are compelling energy companies to recalibrate their production efforts toward offshore sources that aren’t vulnerable to terrorism or political disruption.
Importantly, the average age of Seadrill’s floating rigs is about five years, making them the newest and most technologically up-to-date among the company’s peers. The youth of its rigs gives Seadrill a competitive edge when negotiating rates with its major oil company customers and helps ensure long-term cash flow.
With a 12-month trailing price-to-earnings (P/E) ratio of only 1.73, Seadrill stock is a bargain that faces outsized prospects.
As of this writing, John Persinos did not hold a position in any of the aforementioned securities.
