Seadrill Ltd (NYSE:SDRL) is deep into penny-stock land these days. A low-priced stock is often a bad investment. Just because it’s cheap, doesn’t mean it’s a bargain. Too often, while there can be huge gains in penny stocks, the risks are huge, as well. Given its recent problems, SDRL stock is not what it once was.
Seadrill used to be a high-flying company. Its shares traded in the double digits, offered a 10%-plus dividend yield, and appeared to be run by a brilliant manager. That perception has now changed.
Regardless of its past merits, the company has fallen on hard times. Its subsidiaries, such as North Atlantic Drilling Ltd. (NYSE:NADL), have lost virtually all their value. Drilling activity has declined sharply as the price of oil has remained persistently low. And now, even Seadrill looks to be facing a real risk of bankruptcy.
Trading for less than 50 cents a share, investors have to ask: Is SDRL stock a bargain here, or is it likely heading all the way to zero?
Let’s take a look at the pros and the cons.
3 Cons for SDRL Stock
Chapter 11 Risk: Seadrill built its empire on debt, big piles of it. Had oil prices held up, this strategy might have earned shareholders a fortune. But oil plunged before the company’s mortgaged assets were out of hock.
This has left the company with an untenable debt position. Seadrill is trying to address that risk, actively renegotiating with the bondholders. Management has said that it intends to finish up the process by July 31.
The trouble, though, is that the company has maintained that current common stockholders will likely receive “minimal recovery”. This suggests that the debt holders, as is generally the case, will get the lion’s share of new Seadrill equity as a result of any restructuring.
Overvalued Stock: With more than 500 million shares outstanding, SDRL stock is worth more than investors might think, even at 45 cents a piece. Do the math and you’ll get a market cap of around $225 million.
That’s a rather large figure for a company likely to enter bankruptcy. Most success stories surrounding bankrupt stocks generally hinge on the common equity’s market cap falling to a far lower level. Creditors may well hand out a few crumbs to existing SDRL stock holders, but they’re unlikely to give up anything close to $225 million in value necessary to justify today’s price, let alone enough to cause the stock to rally.
Bitter Economic Headwinds: Seadrill’s situation is particularly dire since the E&P sector remains deeply depressed. Each successive quarter see more of Seadrill’s rigs go off contract, causing revenues to further decline while the company’s interest burden remains unwaveringly high.
Any new contracts Seadrill can get are coming at far lower prices. A new contract for the West Freedom rig in Colombia, for example, will yield less than half the day rate that it had previously earned. Seadrill’s debtload is simply too high to endure such drastic erosion of revenue.
If the price of oil were already recovering, it’d be easier to take a gamble on the stock turning around. But with Seadrill’s operating position getting worse, there’s little reason to think the common stock has enough time to ride out the downturn before it is put out of its misery.
3 Pros for SDRL Stock
Chapter 11 Isn’t the End: While there is a good chance that Seadrill will file for bankruptcy protection, that isn’t necessarily the end of the road for SDRL stock owners. Creditors often give the owners of existing stock a small portion of the ownership position in the newly restructured company.