Grab Fat Dividends With Seadrill or Ensco

Does a 10% yield interest you? Thought so.

Jul 7, 2014 at 6:38PM

Source: Seadrill.

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some oil-services companies to your portfolio but don't have the time or expertise to hand-pick a few, the Market Vectors Oil Services ETF (NYSEMKT:OIH) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in many oil-services companies simultaneously.

Why this ETF, and why oil services?
Companies that do a lot of exploration can be intriguing for those looking to invest in the energy industry. But they don't always strike oil. Consider instead the companies that provide equipment and services for those explorers. They tend to be less well known than the ExxonMobils and Chevrons of the world, but many have been better long-term investments. With shale oil, fracking, and offshore drilling growing more important to the industry, demand for services is likely to continue rising over the long run.

ETFs often sport lower expense ratios than their mutual fund cousins, and this asset-laden fund charges just 0.35% annually. It's a newish ETF that slightly lagged the world market in 2013 but has trounced it this year.

A look at some components
Seadrill (NYSE:SDRL) and Ensco (NYSE:ESV) are among the roughly 25 oil-services companies in this ETF.

Seadrill will have many investors drooling at its 10% dividend yield. It's a compelling investment opportunity in some ways, but there's reason to worry, too. The lessor of offshore drilling rigs faces falling prices due to a growing supply of rigs on the market, but a relatively young fleet gives Seadrill an edge. For example, it recently inked a $1.1 billion, five-year deal charging $600,000 per day for a new rig. Seadrill is poised to do well over the long term thanks to the boom in deepwater drilling, which is expected by some to contribute 15% of our daily oil supply by 2030. For instance, more than 600 million barrels of recoverable oil have recently been discovered off the coast of Canada.

Seadrill carries a lot of debt, but it has solid operating cash flow and has been using low-cost debt to invest in new rigs and other means of future growth. It is responding to the growing supply of rigs on the market by suspending future building plans for now, not including the 19 rigs it has under construction. The company's last quarter was surprisingly good, topping estimates and also including a small dividend increase. With a forward P/E ratio near 11, Seadrill stock is appealing, and its dividend is a thick layer of icing on the cake. Still, a lot depends on how well its dayrates hold up and how much of its capacity is used -- and it does have a lot of debt to repay.

Ensco, another operator of offshore drilling equipment, offers a plump 5.4% dividend yield. Its payout has tripled over the past five years, and still has room to grow. Some see the company, along with Seadrill, as the "best of breed" in its industry, liking its relatively low debt, young fleet, and generally high profit margins. On the other hand, its fleet use rate is lower than Seadrill's and not stellar in the industry, either.

Like Seadrill, Ensco is challenged by a rising supply of rigs in the market, which is pressuring dayrates. But also like Seadrill, Ensco recently secured a big five-year contract with French oil titan Total at higher-than-expected prices (starting around $610,000 per day). My colleague Rupert Hargreaves has pointed out that the fat contract could still be renegotiated or canceled, as others have been recently.

Ensco's stock sports a current and forward P/E ratio of about nine, well below its five-year average of 11.5, suggesting that the company is attractively priced. It's well worth considering for your long-term portfolio, offering the potential for both stock-price appreciation and generous dividend income. Just remember that the industry's next few years could be bumpy.

The big picture
It makes sense to consider adding some oil-services companies to your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate its holdings and then cherry-pick from among them after doing some research on your own.

Here's another way to profit from oil
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Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns shares of Seadrill. The Motley Fool recommends Chevron, Seadrill, and Total (ADR). The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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