Houston-headquartered Seadrill Ltd. (NYSE: SDRL) is a $3.4 billion offshore drilling company that maintains a strong balance sheet with $862 million in cash and cash equivalents, a market edge over many of its near-bankrupt industry peers. SDRL’s 2023 EBITDA and FCF targets were close to $500 million and $200 million, respectively. The company can potentially bump FCF to almost 900 million, or one-third of its enterprise value, if it successfully executes the planned contracts over the next two years. SDRL outperformed from the early 2000s till 2014 as day rates touched the $600,000-$700,000 range for 6th and 7th-generation floaters and almost $200,000 for high-spec jack-ups. However, the company came to a grinding halt when oil prices tanked to $35/bbl in 2016 from $105/bbl in 2014. Upstream capex for offshore projects nosedived to bring down rig utilization rate to almost 50% in 2017 from as high as 88% in 2014. Day rates fell fast and significantly impacted SDRL’s revenues, given its already overblown rig count. The situation compelled SDRL to restructure its $12 billion debt in 2016, as day rates remained muted until 2021, but it wasn’t enough, given the uneconomic day rates remaining. The company initiated a second restructuring in early 2022 to end with $944 million in debt and $486 million in cash, adequate to facilitate its floater-focused fleet remodeling strategy. It sold seven jack-ups in 2022 for almost $700 million and acquired Aquadrill for $958 million in the same year, bolstering its fleet with more floating rigs and tender-assisted rigs, later resold for above $80 million. The company has $625 million in debt, comprising a recently refinanced $500 million 2030 fixed-rate note. Here, we summarized a bullish March-end thesis published by JackPineCapital on Value Investors Club.
Drilling rig silhouetted against a setting sun in an offshore location.
The thesis sees potential returns between 175% and 200% over the coming two years based on the company’s historically conservative 10x NTM FCF or 7-8x EV/EBITDA multiples, steady day rates, net cash position, share buyback programs, and a rebounding industry. Seadrill currently has a net cash position of $237 million with no debt maturity until 2030. The company is already profitable, with its relatively new fleet recording a utilization rate of 93%, as 77% of operating capacity was already reserved for 2024 when the thesis was published. SDRL’s rigs generate revenue from being active, but management will reactive three idle rigs only when they secure profitable contracts since they are not cash-strapped or in a hurry to increase revenues. Meanwhile, several industry players have a significant portion of their fleets lying idle, which could take $100 million per rig to make them available for contracts.
It is important to note that the SDRL fleet’s market value based on recent transactions is almost $8.8 billion, while the replacement cost is above $13 billion. Considering steady day rates of between $400,000 and $450,000 for semis and drill ships, the thesis argues that Seadrill could generate yearly EBITDA of $100 million per drill ship and $70 million per semi, which would mean an EBITDA of nearly $1.18 billion and a $900 million FCF from consolidated operations in 2026, after considering corporate expenses. The company plans to sell five jack-ups in the future. After accounting for the jack-ups, the total EBITDA and FCF could further increase to around $1.35 billion and $1 billion, respectively. However, these targets can be achieved only if SDRL renews its contracts. Thankfully, around 50% of the company’s contracts are up for renewal before 2024 ends, with more than 90% of contracts to be repriced next year. The thesis explains that earnings could take off in 2025 as the industry’s rebound could be further propelled by the expected increase in new offshore project sanctioning activity to $226 billion in 2026 from $69 billion in 2020, assuming $70/bbl. The industry is also supported by the relatively high oil prices, better economics due to new techniques, and pent-up demand after a years-long investment slump. More companies are rolling out major offshore projects since that’s where the untapped reserves are left. SDRL also announced a $500 million share repurchase program, representing over 15% of its market capitalization. The thesis highlighted that the company could buy back shares more aggressively to trim outstanding shares by half and still avoid debt if it utilizes the expected $500 million from its planned jack-up sales with almost $500 million in FCF in 2025. The company traded at 7-8x EV/EBITDA during March-end despite high debts and capex projections, which could price it close to $9 billion by 2025-end, in line with its fleet’s current market value.
SDRL is not on our list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 41 hedge fund portfolios held SDRL at the end of the second quarter, which was 39 in the previous quarter. While we acknowledge the potential of SDRL as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as SDRL but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: This article was originally published at Insider Monkey.
