Don't Sell Seadrill

NEW YORK (TheStreet) - Analysts hate the deepwater driller Seadrill (SDRL), which is evident in the four downgrades this month. But I believe that is no reason to sell this stock.

In February, Seadrill released its quarterly results that showed double-digit top and bottom-line growth, but the company set a gloomy picture for the next two years due to the tough business environment. Moreover, Credit Suisse and Bank of America's recent downgrade made things even more difficult for Seadrill's investors. Meanwhile, Societe Generale has said that an unexpected decline in oil prices, as well as an increase in interest rates, can exacerbate Seadrill's problems.

As a result, the company's shares have fallen by 12.4% since the earnings release and 18% for the year to date. They currently around $34.

Despite this decline, Seadrill may look attractive to dividend hunters thanks to its juicy yield of 11.8%. Furthermore, more than 60% of its jack-up rigs are already booked through 2015 and the company is getting new contracts that go into 2016. With a backlog of more than $20 billion, the company can navigate through these testing times.

Seadrill is highly leveraged, with nearly twice as much debt as its equity. The company, however, is shoring up its balance sheet by increasing its order backlog to record levels and through asset sales as well as drop downs.

In its previous quarterly results, Seadrill's revenue and operating income climbed 21% and 28.8%, respectively, from the same quarter last year to $1.4 billion and $568 million.

This was clearly an impressive performance but the company spooked investors when it said that "2014 and 2015 may show slower growth in activity levels than earlier anticipated." Later, Seadrill's CFO said the company is  expecting an uptake in oil and gas expenditure by 2016, which could lead towards a better business environment. Therefore, Seadrill will now focus on utilizing its existing fleet, until 2016, when it could restart its expansion program.

Seadrill operates under a massive pile of debt, with a debt-to-equity ratio of nearly 200, more than twice as large as the ratio of its peers such as Transocean (RIG), Ensco (ESV), and Diamond Offshore (DO). Analysts believe that Seadrill will increase its net-debt by around 26% from the current levels to $17.5 billion by the end of 2015. Therefore, higher interest rates can become problematic for Seadrill. 

Although the next two years can be difficult for the company, the markets seem to me to have overreacted and this could be an opportunity for long-term investors.

The company recently announced new contracts, valued at $319 million, for its four jack-up rigs and the extension of a contract for a single rig at higher day-rates that would fetch an additional $24 million in revenues. Of the four rigs, one has received a long term contract for 2 years, valued at $168 million, while another rig would work for 12 months for $89 million, with an option to extend the contract for another 12 months.

In other words, with these new contracts, the company has shown that despite the tough business environment, Seadrill's units can still get booked well into 2016. With the new deals, nearly 92% of the company's jack-up capacity is contracted out for 2014 and 64% is contracted for 2015.

At the end of 2013, Seadrill's backlog stood at $20.2 billion. The company expects to maintain its backlog at this level in the future. Based on this stability, Seadrill has said that it will continue giving dividends at the current rate. A slowdown in backlog growth can have an adverse impact on dividend growth, but the company is not looking at any dividend cut in the future.

Earlier this month, Seadrill sold 230 million shares it had of the Malaysian oil services company SapuraKencana for $300 million, realizing a total economic gain of $165 million. Seadrill currently owns 490 million, or 8% of the company. 

Moreover, the company is also dropping down its assets to its master limited partnership, Seadrill Partners (SDLP). Last year, in December, the company dropped down two assets to Seadrill Partners for $356 million cash. Seadrill has also said that it will report further drop-downs in the future. 

The sale and the drop-downs come at a good time for Seadrill as the cash infusion from these activities will  enable the company to better manage its debt. The company has already said that it would use 80% of the net proceeds from the drop downs on debt reduction and future growth programs. The company's net debt stands at $13.9 billion, an increase from $12.6 billion in the end of 2012. 

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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