When dividend is paid

When Will Seadrill Ltd. Reinstate Its Dividend?

Dec. 24, 2014 4:46 AM • sdrl

  • As oil prices drop below what is feasible for new projects in the Arctic, supply and demand will be even more challenged.
  • The good news is more and more rigs are getting stacked and retired.
  • For the time being, Seadrill is focusing on debt reduction.

In late November, leading offshore rig owner Seadrill Ltd. (NYSE:SDRL ) suspended its dividend. Most investors in Seadrill were in the stock primarily for income, and so a complete dividend suspension was a difficult pill to swallow.

For the last couple years management claimed that its extensive backlog would keep the generous $2 billion dividend sustainable through 2015. After all, just over 90% of the company's deepwater drillship fleet is contracted for next year.

Unfortunately, sharp drops in oil prices and a general oversupply of drillships has put a lot of pressure on dayrates and management is not sure exactly how much rig dayrates will fall and when dayrates will recover. Perhaps more important in Seadrill's decision to suspend the dividend was the debt market. Next year and the year after, Seadrill has substantial debt that will come due and at the same time, high-yield debt markets look to be souring to energy companies.

While Seadrill's decision to suspend the dividend was a proactive one, income investors who have remained in Seadrill are probably wondering when they will start to get a dividend again. While that is a difficult question to answer, if we look at things like rig market fundamentals and the company's debt maturity schedule, we might be able to get a better idea of when Seadrill could re-establish its dividend.

(click to enlarge)

Courtesy of Seadrill Investor Relations

This chart shows average breakeven costs of oil production around the world. This does not indicate minimum levels at which operations are profitable, but rather a breakeven for new projects. Even still, at $60 oil there will be a lot of projects no longer worth doing. The most affected areas will be Arctic and Oil sands development. Although operations in both regions are very long-term and capital intensive, supply will ultimately be taken out of these places as the price of oil doesn't seem poised to return to levels profitable to either of these subsectors anytime soon.

Seadrill gets most of its revenue from ultra deepwater, where breakevens are only $56 per barrel. Seadrill also, however, has significant exposure to 'offshore shelf' and, through its subsidiary deal with Rosneft, to the Arctic as well. Therefore, the drillship market for ultra deepwater is also connected to Arctic development: Ships displaced in the Arctic can move south to places such as the North Sea, West Africa and the Gulf of Mexico, further stressing dayrates in those areas with yet more rigs.

This, I believe, will extend the 'challenging' market scenario out past what many are expecting. For example, a few quarters ago Seadrill's CEO, Per Wulff, said that he expected the market to be even more challenging in 2015 but that the situation would get better in 2016. Those remarks were made when oil prices were a lot higher than they are now.

While it is difficult to gauge where Brent Crude will ultimately settle down, even in the $70-$80 range the spectrum of oil production will be quite a bit smaller than it is right now. That smaller spectrum will put extended pressure on offshore rig owners such as Seadrill. The bottom line is, we're probably headed to a reality where E&P companies need considerably fewer ultra deepwater rigs than what is now available.

Compounding this problem is that there are still dozens of drillships under construction as we speak. According to a report by Seadrill Partners (NYSE:SDLP ), there are some 250 active drillships right now. Another 65 are scheduled to be delivered

by 2016. For the market to stabilize there will probably need to be a good deal more than 65 rigs either retired or stacked over the next three years.

Courtesy of Seadrill Investor Relations

The good news is, that might be happening right now. From July to October alone the number of cold stacked rigs jumped from 20 to 27. Of the 250 floaters out there, some 80 of them are over 30 years old and could be retired soon. In order for the drillship market, and Seadrill in particular, to find the stability and profitability it needs in this new paradigm, all 80 of these will need to be retired over the next three years, and perhaps even more than 80.

Micro picture

Courtesy of Seadrill Investor Relations

Seadrill's drillship fleet is among the youngest and most efficient in the industry, and contracts on these ships therefore fetch a higher dayrate than do those of most other rig owners. For example, Seadrill's latest deal with Petrobras (NYSE:PBR ) fetched implied dayrates of just over $500,000. Most drillship owners these days are happy to get $450,000, if even that much. Seadrill has an operational advantage here.

The above chart shows just how profitable Seadrill's operations still are. Notice that Seadrill's rigs have a 'cash flow breakeven' of just $369,000 per day, including an annual 10% principle reduction on outstanding debt. Those worried about whether Seadrill can survive these difficult times would do well to consider this chart. Seadrill can operate and even pay off debt with dayrates as low as $369,000. And remember, most of Seadrill's rigs are currently under contract with dayrates between $550,000 to $600,000.

Data from Seadrill 3Q 2014 quarterly report

Seadrill is a highly levered company, and in an environment where credit markets might be turning against energy companies, management sees a pressing need to delever and clean up the balance sheet. Consider this: Seadrill earned $2 billion in cash flow during 2014, all of that was paid to shareholders in the form of dividends. Next year, over 90% of the company's drillships are contracted and a majority of shallower water jackups are, too. By applying cash flow to paying off debt, Seadrill will delever significantly. The company will be able to take care of most maturing debt obligations and will likely be able to refinance the remainder at relatively favorable terms.

We have every reason to believe that Seadrill will continue to be profitable in this environment. And with the company now turning its considerable cash flow to paying off debt, Seadrill will be substantially delevering and retiring as much debt as it can through at least 2015. In other words, the company will be able to get through this tough time.

But what about the dividend? Seadrill will probably reinstate the dividend when management feels comfortable about its debt in relation to credit markets, and when dayrates have stabilized at an appropriate level and more when foresight is possible. From what we can see with both dayrate fundamentals and the company's leverage, I foresee the company delevering for the next two to three years. depending upon how many floaters get retired over that time period.

Afterwards, Seadrill should have a much better balance sheet and the drillship market will fully benefit the rig retirements that are bound to happen. As a stock, Seadrill has been a big loser, there's no doubt about that. As a business, however, Seadrill is a great operator that has come upon a difficult macro environment but can still operate profitably.

Disclosure: The author is long SDRL.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: m.seekingalpha.com

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