2023-11-30 07:00:31 ET
Summary
- Seadrill receives a buy rating due to attractive market fundamentals, compelling valuation, and high capital returns.
- Q3 results exceed expectations, with strong revenue and EBITDA performance.
- Seadrill announced additional share buybacks and reinforced its positive outlook on market fundamentals.
- SDRL shares remain very attractive at the current valuation.
We have initiated on Seadrill (SDRL) with a buy rating , highlighting attractive market fundamentals for offshore drillers, a compelling valuation, and high capital returns. In this note, we will analyze Q3 results, briefly discuss the impact of the longer idle time for two drillships, and revisit our forecasts and investment case. We recommend readers check our previous note to get a better understanding of the business and key value drivers.
Seadrill Q3 earnings results
Seadrill had strong Q3 results with revenue coming in at $414 million, or nearly 4% above sell-side analysts' consensus expectations, and EBITDA coming in at $151 million or more than 20% above consensus. The EBITDA beat is attributable to cost optimization i.e., lower sales, general, and administrative expenses as well as a better than expected result from management agreements. Cash generation and net financial position also outperformed consensus, also supported by a lower capex vis-à-vis expectations. Moreover, the company announced a guidance upgrade with revenue expected to be between $1495 million and $1515 million and EBITDA expected in the range of $485 million and $505 million. Moreover, capex is expected to be lower in the range of $185 and $205 million. All new guidance lower bounds are better than consensus expectations. We view the results very positively and we are further reassured.
Moving to capital allocation, Seadrill announced an additional share buyback of $250 million, pushing the total to $500 million, or effectively 14% of the current market capitalization. We believe this sends a powerful message about the firm's strong outlook on market fundamentals.
Seadrill announced the award of two new contracts for Tier-1 drillships West Vela (short term) and West Neptune (effectively a contract extension) respectively at $450k and $385k day rates. The day rates are a reflection of strong underlying fundamentals. Seadrill had previously announced that two of its drillships: Polaris and Auriga which are expected to mobilize in Brazil, will have longer idle times. While we adjust FY2024 slightly down to account for this, this does not affect the valuation and investment thesis.
SDRL stock - Investment case, valuation, and capital returns
We value Seadrill using EV/EBITDA ratios and FCFF yields. We have updated our forecasts to better reflect new changes such as the longer idle times for the two drillships discussed above - although the change is not major. We now forecast an EBITDA of $480 million in FY2024 (around 10% below consensus) and $800 million in FY2025. We moreover forecast ca $1 billion of EBITDA in FY2026 as three drillships working at relatively low rates for Petrobras in Brazil will be repricing. Despite our slightly lower forecasts, Seadrill remains attractive. Seadrill is currently trading at 7x forward EBITDA. The EV/EBITDA ratio drops significantly to 4x when taking into account 2025 financials and to 3.3x for 2026 numbers. We value Seadrill at 5x 2025 EBITDA and arrive at a target equity value of $4.3 billion implying a 20% upside. We forecast $600 million of FCFF in 2025, implying an FCFF/EV yield of 18%. We would also like to note Seadrill's low EV relative to its steel value. We believe Seadrill offers a high teen IRR over the mid-term. Catalysts include continued strong operating and financial performance and higher capital returns.
Clearly, applying more optimistic underlying assumptions on day rates and utilization would produce a higher valuation, but we remain conservative. We find Seadrill attractive relative to other offshore drilling contractors as well as compared to the broader energy services sector.
Risks
Risks include but are not limited to deteriorating macroeconomic conditions, a decline in crude oil prices, an increase in newbuilds leading to excess supply and deterioration of market fundamentals, value destructive M&A resulting in an increase in net leverage, technological improvements in shale, changes in drilling technology and customer demand for upgraded technology, accidents, and weather events.
Conclusion
We recommend buying Seadrill shares, as we find the risk/reward highly attractive. We believe this is the beginning of a multi-year period of outperformance for offshore drillers and Seadrill in particular. The valuation remains compelling, and we think investors can earn an IRR in the twenties over the mid-term.
For further details see:
Seadrill: Investment Case Remains Compelling