Even though Seadrill Ltd (NYSE:SDRL) is at penny stock levels, the company still has many fans on Wall Street. Note that the company has valuable assets. For example, it operates a fleet of 68 rigs, which consist of drillships, jack-up and semi-submersibles that can deal with shallow to ultra-deepwater areas. Seadrill also has a global footprint, with offices in Oslo, Dubai, Houston, Rio De Janeiro and Ciudad del Carmen.
Something else: The latest earnings report showed that the company can find ways to generate cash, with net income hitting $57 million.
All this is encouraging, right? True. But then again, there is much to be worried about as well. There are certainly solid reasons why SDRL stock has lost nearly 90% of its value during the past year.
And, the company has not been alone, either. Many of its peers have also suffered major drops in their valuations, such as Rowan Companies PLC (NYSE:RDC), Atwood Oceanics, Inc. (NYSE:ATW) and Pacific Drilling SA (NYSE:PACD).
So, what are the main problems to consider with SDRL stock? Well, let’s take a look at three.
SDRL Stock Problem #1 — Liquidity
This is, perhaps, the biggest threat to SDRL stock as the company has a crushing debt of $14 billion. No doubt, the shipping business is capital-intensive. But, even worse for the company is that it invested heavily in its business when crude prices peaked in 2014.
The bottom line is that Seadrill does not have enough cash on hand to pay its next tranche of debt. To deal with this, the company has set a deadline for the end of July to try to find ways to restructure the terms.
But, for shareholders, there is not much leverage. Keep in mind that common stock is — by law — last in line to get any proceeds from a liquidation. As a result, debt holders are likely not to get much of the benefit of the restructuring.
As InvestorPlace’s James Brumley has noted: “The trouble, though, is that the company has maintained that current common stockholders will likely receive ‘minimal recovery.’ “
SDRL Stock Problem #2 — Revenue Threats
If market conditions remain challenged, then the revenue base will certainly be subject to much further declines. Some existing customers can terminate their contracts without cause. They may be required to pay a fee for this, but this may not necessarily make up for the shortfall. Besides, the customers might just wind up litigating — such as by claiming impaired performance because of operational issues or force majeure events. It’s also important to note that national oil companies likely have “outs” with their contracts.
But, isn’t the backlog about $3.6 billion for Seadrill ? It is, but the backlog is really only an educated estimate. If customers do indeed push back on their contracts, then that amount could quickly dwindle. What’s more, the idle rigs will still incur costs for maintenance, docking and insurance.
SDRL Stock Problem #3 – The Oil Market
According to InvestorPlace.com’s Ian Bezek:
“Some say oil needs to be priced between $65-$75 per barrel for Seadrill to have a legitimate shot at paying all of its bills as the company is capitalized right now, and that’s just not in the cards any time soon.”
The price of crude is at only $43 per barrel. Interestingly enough, Seadrill management does not seem to be very hopeful about the prospects of improvement.
According to a recent SEC filing:
“The significant decrease in oil and natural gas prices is expected to continue to reduce many of our customers’ demand for our services in 2017, due to significant decreases in budgeted expenditures for offshore drilling.”
In other words, if crude oil continues to fall, there will inevitably be lower day rates, which will put even more pressures on the top and bottom lines.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is the author of various books, including All About Commodities, All About Short Selling and High-Profit IPO Strategies. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.