Buying Seadrill (SDRL) today would be speculative.

Morningstar initiated credit coverage of Seadrill (SDRL) today with an issuer rating of B.  Morningstar is concerned that Seadrill will not be able to pay for existing debt interest, add additional debt interest from planned rig purchases, and maintain its high dividend.  I share their concern.

I haven’t performed the methodical, deep analysis on Seadrill yet, but this information is not encouraging.  I believe that Seadrill common stock is too expensive to be bought as an investment right now.  Let me explain.

I didn’t compute Seadrill’s 2010 earnings in my last article that used Seadrill as one of the examples of investment and speculative stocks: .  I only computed the EPS through 2009.  I was attempting to compute Seadrill’s average earnings over 5 years, but Morningstar wouldn’t display the 2010 earnings.  However, the quarterly filings were available and I have since computed the 2010 EPS.

The following table is computed by using the net income available for common shares divided by current quantity of common shares (380.86 M):

            EPS (adjusted for changes in capitalization)

2006    $0.56

2007    $1.32

2008    ($0.43)

2009    $3.31

2010    $3.08

Seadrill’s five year average earnings (2006-2010) were $1.57 per share.  I recommend that you don’t pay more than 20 times the 5 year average earnings for any common stock to make an investment.  $1.57 x 20 = $31.40 per share is the upper limit for an investment basis.  Seadrill’s current market price is $37.21; therefore, Seadrill would qualify a speculative purchase at today’s market price.

I would consider buying Seadrill for under twelve times the 5 year average earnings.  $1.57 x 12 = $18.84 per share for a value investment basis.  SDRL last traded for $18.84 back in September 2009.

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New Credit Rating: Seadrill

by Morningstar Credit Committee | 04 Apr 11 

Morningstar is initiating credit coverage of Seadrill SDRL with an issuer rating of B. Seadrill is a leading offshore drilling contractor for the oil and gas industry. Our rating reflects the firm’s aggressive business strategy of fully debt financing its rig construction program, stretched credit metrics, and aggressive dividend policy.

At the end of 2010, Seadrill had about $9.2 billion in total debt versus about $1.4 billion in available cash and marketable securities and $1 billion in investments. The debt is broken into $5.2 billion in credit facilities and debt that is secured by Seadrill’s rigs, $1.8 billion in Ship Finance sales and leaseback transactions, and $2.2 billion in bonds, convertible bonds, and credit facilities supported by restricted cash. In early 2011, Seadrill bought two deep-water rigs for $1.2 billion, financed using bank debt. We estimate that at the end of 2011, Seadrill’s EBITDA/interest ratio will be around 5.2 times, its debt/capital will be around 0.73, and its debt/EBITDA will be 4.7 times. Despite these stretched credit metrics, Seadrill currently pays out more than $1.0 billion in dividends annually.

In addition, Seadrill faces near-constant financing challenges. The majority of Seadrill’s debt matures in five to seven years, and we estimate it has $5.2 billion coming due in the next three years. We do not think Seadrill’s cash from operations will be enough for its needs, given its already announced rig construction spending of $4.6 billion. We estimate Seadrill will generate between $1.9 billion and $2.3 billion in operating cash flow annually over the next three years, or about $5.7 billion in the aggregate. Therefore, Seadrill needs to fill a financing gap of about $4.1 billion.

From a risk perspective, Seadrill’s financial leverage has amplified its exposure to the inherent cyclicality of the contract drilling industry. Market day rates are volatile and outside drillers’ control, which contributes to significant swings in profitability on a short-term basis. In addition, explosions, hurricanes, and government expropriation introduce tail risk to the firm’s operations.

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Published in: on April 4, 2011 at 11:13 am  Leave a Comment  

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