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Seadrill Limited (NYSE: SDRL ) plunged over 6% when the company announced a quarterly dividend hike by $0.04 to $0.95, or 4.3%. Typically a dividend hike is greeted with positive stock returns, but in this case investors appear more concerned by other issues in the sector.
Seadrill is a global leader in offshore drilling with a fleet of modern, high-specification rigs. The company is a serial deal maker with a 77.5% ownership of Seadrill Partners (NYSE: SDLP ) and a recent deal to acquire the majority of Sevan Drilling. The addition of Sevan during the quarter added operating costs that reduced the bottom line.
In reality, the more concerning news to investors was outside the control of the company. Iran made a deal that could lead to more oil supply on the market, and Seadrill made some concerning comments about rig demand in the earnings release. This news could be significant for Atwood Oceanics (NYSE: ATW ) , which has been equally aggressive on building new rigs.
Quarterly dividend hikes
As mentioned, Seadrill hiked the dividend to $0.95 a quarter. With an annual dividend of $3.80, the stock now yields nearly 9%. For a stock with a market cap approaching $20 billion, Seadrill has one of the highest dividend yields around. As the table below highlights, the dividend has consistently increased since the fourth quarter of 2009 and only had a minor hiccup in the depths of the financial crisis:
Table – Seadrill dividend history
An interesting note is that Seadrill yields far more than the 5.3% of Seadrill Partners, which was set up specifically to distribute income as a master limited partnership. Other rig operators either pay limited dividends or no dividends, as is the case of Atwood Oceanics.
The news on a nuclear settlement with Iran undoubtedly hit most stocks involved in exploring and drilling for oil. The most concerning news from the day was Seadrill suggesting oil companies are encountering a period of challenged cash flows and will be required to reexamine budgets. The company went on to state that the offshore drilling market has gone from being under-supplied to adequately supplied with rig operators encountering challenges in 2014. These items clearly raised red flags regarding future demand.
If investors stopped listening at that point, they might have a negative outlook on the sector. The company quickly changed the tune to challenges being felt specifically by lower specification assets. In essence, the market needs the new, high-performance rigs in order to drill the technically complicated wells today. Seadrill suggests that the modern, high end of the asset class will see utilization at around 100%. Seadrill has aggressively transitioned to a mostly modern fleet.
The transition to the modern fleet includes Seadrill taking delivery of six new rigs during the third quarter and having 21 more rigs under construction. In total, the company only operated 40 rigs during the quarter. Atwood Oceanics already obtains more than 50% of its revenue from high specification rigs and has four ultra-deepwater drillships under construction. The company only operates 13 drilling units, providing considerable upside from these new ships.
The recent requirement of Mexico to increase oil production and upgrade its operating fleet of rigs naturally presents an opportunity for Seadrill. The company has entered into an agreement with PEMEX for five potential jack-up contracts starting in 2014. The cumulative duration of the contract is more than 30 rig years with substantial total revenue in excess of $1.8 billion, or equal to roughly 10% of the current backlog.
The agreement is significant to the industry in that Seadrill is being forced to terminate contract discussions with other operators in order to free up the rigs for the substantial work in Mexico. Seadrill even suggests that the operators have been forced to push out their drilling programs. In fact, the jack-up global contracted fleet is highly populated with 200 units that are over 30 years old, providing ample opportunity for newbuilds to force these aging rigs into the scrap yards.
In the end, it's difficult to tell what specific reason caused Seadrill to plunge 6%. The company had disappointing earnings and the Iran settlement to scare off investors, but fellow aggressive rig builder Atwood Oceanics only dropped 3.6%. If anything, investors should use the drop to take advantage of a very attractive dividend hike. The aggressive newbuild programs by both Seadrill and Atwood Oceanics set the stocks up for long-term success.
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