Buy, Sell, or Hold: Seadrill

When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether its possible upsides outweigh its risks. Let's take a look at Seadrill (Nasdaq: SDRL  ) today, and see why you might want to buy, sell, or hold it.

Founded in 1972, based in Bermuda and with a market capitalization of about $19 billion, Seadrill serves the global oil and gas industry with offshore drilling services.

Buy
One reason to consider buying the company is its industry. Despite the growth of alternate energies, oil and gas are likely to remain in considerable demand for the foreseeable future. And with lots of low-hanging fruit already plucked, oil and gas companies are often in need of specialized drilling services to get at trickier-to-access reserves.

Seadrill has developed a specialty in ultra-deepwater drilling, which distinguishes it from more diversified competitors, such as Transocean  (NYSE: RIG  ) and Noble  (NYSE: NE  ) , and others, such as Hercules Offshore (Nasdaq: HERO  ) , which is focused on shallow-water drilling. One advantage of this is that deepwater contracts tend to be longer-term than others, providing more reliable income streams. (Some worry, though, that deepwater disasters, such as the recent one in the Gulf of Mexico, will lead to a reining in of deepwater drilling. Another big disaster could cause big problems for the companies involved.)

Demand for deepwater drilling is high, and in a second-quarter report, the company's CEO stated: "Since our last reporting we have secured new contracts with an estimated revenue potential of US$7.6 billion, reflecting both our clients' satisfaction with our operations and the strong demand for high-specification quality equipment." He also cited a "record high" order backlog and a "strong market outlook." 

Another draw for investors is the stock's dividend, which recently yielded a whopping 8.3%. The dividend has only been paid for about two years, but it has grown quickly in that period, from $0.60 per share to the recent $0.84. The growth hasn't been in a straight line, though, and the current payout far exceeds the company's earnings per share, so some wonder whether a dividend cut is in the offing. The dividend may well remain robust, though, particularly if earnings keep rising. Investors may just want to keep an eye on things.

In the company's second quarter, revenue advanced 7%, and operating profit rose by 6%. As my colleague Travis Hoium recently noted: "Three of the company's rigs are booked beyond 2016, and dayrates have risen to near records of around $600,000 per day." Earlier this year, Travis dubbed Seadrill "the best offshore drilling stock."

Sell
One reason to consider selling or steering clear of Seadrill is its debt, which has ballooned from less than $5 billion in 2007 to around $10 billion at the end of 2011 (I'm including short-term debt here, as well as long-term). Cash totaled only $507 million by the end of 2011.

Meanwhile, the company's free cash flow is negative, and has been negative for quite a while, largely due to hefty investments in property, plant, and equipment.

Other worries include increased competition, the possibility of a glut of deepwater rigs depressing prices eventually, and falling prices for oil, which can decrease enthusiasm for offshore drilling.

Hold
Given the reasons to buy or sell Seadrill, it's not unreasonable to decide to just hold off. You might want to wait for its debt level to subside, for example, or for it to line up even more contracts.

You might also look at others in Seadrill's midst, such as DryShips' subsidiary Ocean Rig UDW (Nasdaq: ORIG  ) which is also building ultra-deepwater rigs and signing big contracts, though both companies are  saddled with a lot of debt, too.

The verdict
I actually already own a few shares of Seadrill. Whether you should, too, is up to you. It may perform spectacularly in the coming years, but there are plenty of other compelling stocks out there. Everyone's investment calculations are different, so, do your own digging and see what you think.

If you'd like to learn much more about Seadrill and its prospects, check out the premium report on it that our analysts have prepared. It gives background on the company and highlights the three areas investors must watch. It also comes with a year of free updates on the company, so find out more by clicking here.

Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, owns shares of Seadrill, but she holds no other position in any company mentioned. Click here to see her holdings and a short bio. The Motley Fool owns shares of Transocean and Seadrill. Motley Fool newsletter services have recommended buying shares of Seadrill. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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