SeaDrill's Dividend X-Ray

Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a company to understand the quality of its dividend and see how it's changed over the past five years.

The company we're looking at today is SeaDrill (Nasdaq: SDRL  ) , which yields 0.8%.

Industry
SeaDrill is a deep-sea driller, competing with other drillers such as DryShips (Nasdaq: DRYS  ) subsidiary Ocean Rig (Nasdaq: ORIG  ) . Besides the Macando oil disaster, which shut down drilling in the Gulf of Mexico for six months, the industry has largely been doing very well, as high oil prices and new discoveries have kept up demand for deep-sea drilling rigs.

Seadrill Total Return Price Chart

Seadrill Total Return Price Chart by YCharts

Dividend
To evaluate the quality of a dividend, the first thing to consider is whether the company has paid a dividend consistently over the past five years and, if so, how much it has grown.

Seadrill Dividend Chart

Seadrill Dividend Chart by YCharts

SeaDrill's dividend has been slowly rising since its IPO in 2010. The two dips you see in the graph are special dividends the company paid out in addition to its regular quarterly dividend.

 Immediate safety
To understand how safe a dividend is, we use three crucial tools, the first of which is:

  • The interest coverage ratio, or the number of times interest is earned, calculated by dividing earnings before interest and taxes by interest expense. The interest coverage ratio measures a company's ability to pay the interest on its debt. An interest coverage ratio less than 1.5 is questionable; a number less than 1 means that the company is not bringing in enough money to cover its interest expenses.
Seadrill Times Interest Earned TTM Chart

Seadrill Times Interest Earned TTM Chart by YCharts

At 11.36 SeaDrill covers every $1 in interest expense with over $11 in operating earnings.

Sustainability

The other tools we use to evaluate the safety of a dividend are:

  • The EPS payout ratio, or dividends per share divided by earnings per share. The EPS payout ratio measures the percentage of earnings that go toward paying the dividend. A ratio greater than 80% is worrisome.
  • The FCF payout ratio, or dividends per share divided by free cash flow per share. Earnings alone don't always paint a complete picture of a business' health. The FCF payout ratio measures the percentage of free cash flow devoted to paying the dividend. Again, a ratio greater than 80% could be a red flag.

Source: S&P Capital IQ.

SeaDrill has been heavily investing in new drillships, and as such, its free cash flow payout ratio is all over the place. Its earnings payout ratio is near 70% and is more representative of the business.

Alternatives

Source: S&P Capital IQ.

There are some alternatives out there in the industry. SeaDrill has both the highest yield and payout ratio, but Transocean (NYSE: RIG  ) has the second highest yield at 7.9%. However, it wasn't profitable the past 12 months and sports a negative payout ratio. Diamond Offshore Drilling (NYSE: DO  ) has a 6.3% yield and very low 6.8% payout ratio. Ensco (NYSE: ESV  ) rounds out the group with a 3% yield and a 47% payout ratio.

Another tool for better investing
Most investors don't keep tabs on their companies. That's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. We can help you keep tabs on your companies with My Watchlist, our free, personalized stock-tracking service.

For more dividend stock ideas, get The Motley Fool's free report: "11 Rock-Solid Dividend Stocks."

Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. The Motley Fool owns shares of Ensco and Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 17, 2011, at 1:12 PM, isitf8 wrote:

    Am I missing something. Diamond Offshore's div is about 1%; it took a big cut in July 2010.

  • Report this Comment On December 17, 2011, at 8:41 PM, ggbudfox wrote:

    "The company we're looking at today is SeaDrill (Nasdaq: SDRL ) , which yields 0.8%."

    Actually, it yields 8%. Funny thing about those tricky decimal points...

  • Report this Comment On December 19, 2011, at 9:36 AM, artmuseum wrote:

    Nice but incomplete - NO mention of John Fredriksen, our Chairman, the financial engineering genius which propelled SDRL to #1 among drillers at breath-taking speed.

    Call him the "rich uncle" of SDRL

    = worth near $10Billion when I last checked =

    whose mere presence ensures

    1. most favored interest rates +

    2.entrepreneurial agility.

    Just 1 recent example: SDRL is cracking the huge barriers in the exiting Brazil bonanza, with a new Brazilian entity, RIG kicked out for an oil leak.Charts are great if supplemented with the most important element sadly neglected by Wall Street - the HUMAN element = priceless!

  • Report this Comment On December 20, 2011, at 5:49 AM, divinediscerner wrote:

    Sdrl has very high insider ownership. Typically, but not always, that means mgmt is more aligned with shareholder interests. Something I consider very important.

  • Report this Comment On December 20, 2011, at 5:57 AM, divinediscerner wrote:

    I should add sdrl is my largest holding of high beta stocks (of which I own very few these days, preferring the safer defensive stocks). The dividend isn't bullet proof, but mgmt appears to be doing a great job of growing the business and the dividend is very compelling. I'd rather own sdrl than a junk bond fund (that pays about the same dividend) since the potential for capital growth is far better.

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