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I Sea The Value In Seadrill - $SDRL $SDLP

By Jack Ryan

A few months ago, I published an article about one of my favorites in the drilling industry, and today, due to some very specific reasons, (like low-price/free-cash-flow companies with a low capex-to-sales ratio, for example) I am reiterating my long positions on Seadrill Partners LLC (SDLP), a subsidiary of Seadrill Limited (SDRL). While I have been suffering from the up and down volatility a bit in the company, to reassure myself of my own position I wanted to do a deeper analysis as to the reasons why the stock price is so cheap and why it presents a “potential” value opportunity to so many analysts as well.First off, the numbers (which, presumably, are factored into the current stock price). The company produced revenue of $385.9 million last quarter, up around 48% vs. the same quarter in the previous year. Operating profit also increased substantially by 54%, with net profit up 92%. Moreover, gross margins improved by 4% to 70.51%, operating margins improved by 4.02% to 49.42%, and net margins improved by over 30% to 9.90%. The price/sales ratio is 0.88, which puts the company a reasonable 10th of 19 businesses in the same industry, ranked by lowest P/S. Price/EBIT stands at 1.83, and price/book at 0.63. Based on this last metric alone, the book value (assets minus liabilities) of $1,997.2 million puts the liquidation value share price at $21.69, which is 59% above the current share price of $13.58. The improving Piotroski F-Score (the measure of company health based on the balance sheet) currently stands at 7/9 (77.7% rating).

Next, let’s take a look at analyst recommendations. According to MarketWatch data, analysts are rating SDLP as a strong buy, with 30% upside from the current $13.58 share price.

All these numbers raise the question: Why is the stock price so low? And what is stopping the die-hard data-driven institutional investors, insiders and high net worth folks from jumping on this stock? Alas, the deep-value status of SDLP comes down to one thing that has been on the minds of almost every investor of late — the movement and future expectations in the oil price.

While the company is strong, with unquestionable quality in the delivery of its services, sustainable clientele, an enviable balance sheet (especially within the energy equipment/services industry), as an energy equipment services provider SDLP relies heavily on third-party accounting/budgeting decisions. Some of those decisions are whether or not these companies (such as British Petroleum (BP), Chevron (CVX), and Exxon Mobil (XOM)) will (or will not) terminate contracts as part of their wider plan to cut their own capital expenditure.

For instance, currently SDLP boasts a strong, substantial order backlog of some $5.5 billion. However, with companies such as BP watching their own capex very closely, these industry giants could cut 2015/2016 capex, which would directly impact Seadrill and similar service providers. The factoring in of this risk is, in my view, the root cause of the currently low share price. If oil goes up and capital expenditures continue (or are reinstated), investors can expect SDLP shares to follow suit. And the share price (factoring in low oil prices) is undervalued to a point where it could move substantially.

There is real risk here, however. For instance, with regard to BP alone (with whom Seadrill has three contracts), there have been capex reduction announcements to the tune of $20 billion in 2015. SDLP is very much sensitive to these third-party decisions.

If the thesis that oil prices are the direct determinant of whether the likes of BP, Chevron, and Exxon Mobil cut (or increase) their capital expenditure stands, then — in my view — Seadrill offers an exceptional opportunity for those who want to play a steady/rising oil price. Whether this is likely or unlikely is anyone’s guess (I am personally skewed toward a short-term tight range to long-term bullish). However, I believe buying into a business such as SDLP offers a good opportunity to capitalize on oil, as opposed to playing the vanilla long/short crude.

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