Seadrill Warns Of Near-Term Headwinds, But Long-Term Outlook Still Solid

Note:

Seadrill Limited (NYSE:SDRL) has been covered by me previously, so investors should view this as an update to my earlier articles on the company.

Stock Under Pressure Despite Massive Share Buybacks

After marking a new 52-week high in early September, shares of leading offshore driller Seadrill Limited or "Seadrill" have retreated by more than 20% in recent weeks.

While more or less in line with peers, the setback would have likely been much worse without the company aggressively buying back shares in the open market under its recently announced $250 million share repurchase program:

Between September 12 and October 30, Seadrill repurchased more than 4% of the company's outstanding common stock for approximately $143.5 million or $43.61 per share on average.

At the current buyback pace, Seadrill's share repurchase program would be exhausted by year-end.

While the company commands a pristine balance sheet with plenty of liquidity, I am surprised by Seadrill's aggressive approach to share repurchases given the fact that most of the company's fleet is still working on legacy contracts at painfully low or even entirely undisclosed rates thus limiting near-term cash flow from operations:

Company Warns of Near-Term Headwinds

In the most recent presentation, the company also points to a number of "emerging headwinds" for next year:

• increased idle time
• high-single digit inflationary pressures
• heavy maintenance requirements

Based on the company's August fleet status report, I would expect the rigs Sevan Louisiana, West Polaris, West Auriga, West Phoenix, and potentially West Vela facing some near-term idle time as market conditions in the U.S. Gulf of Mexico have softened in recent quarters and activity in the North Sea is unlikely to pick up meaningfully before 2025.

While Seadrill had offered the West Phoenix for work in the Black Sea, the rig is now likely to remain in Norway following the end of its current contract in August 2024.

In addition, the company is facing headwinds from an elevated number of special periodic survey requirements as 13 out of 16 active rigs are scheduled for drydocking in 2023 and 2024 with the former Aquadrill units reportedly requiring some catch-up work.

Reducing Estimates But Stock Remains A Buy

Consequently, I am pushing out my expectations for profitability to reach an inflection point by twelve months.

However, Seadrill's shares remain inexpensive based on my 2025 Adjusted EBITDA estimate of $700 million:

Assigning an EV/Adjusted EBITDA multiple of 6x would yield a $60 price target for the shares thus providing for almost 50% upside from current levels:

According to CEO Simon Johnson's statements at last month's Pareto Energy Conference, the company expects the market to track sideways for the next months.

Considering the above-discussed headwinds, I do not expect the stock price to reach new highs in the near term but investors looking for exposure to an industry with solid fundamentals and some lasting tailwinds from recent geopolitical events, should consider scaling into Seadrill's shares on weakness.

Bottom Line

Seadrill warned investors of a number of near-term headwinds going into 2024 with increased idle time and heavy maintenance requirements in combination with inflationary pressures likely to impact profitability and cash generation quite meaningfully.

As a result, I have reduced my near-term estimates for the company. However, the stock remains cheap based on my expectation for a 40% year-over-year increase in Adjusted EBITDA in 2025.

Considering ongoing, strong industry fundamentals as well as Seadrill's best-in-class balance sheet and liquidity, I am reiterating my "Buy" rating on the shares with a price target of $60 based on a 2025e EV/Adjusted EBITDA multiple of 6x.

Key Risk Factor:

Offshore drilling stocks are heavily correlated to oil prices so any sustained down-move in the commodity would almost certainly result in Seadrill's shares taking a further hit.