Is this Dividend Really as Dangerously High as Many Believe?

Seadrill's (NYSE: SDRL  )  dividend is one of the most scrutinized in the energy sector. Indeed, with a yield of 9.4%, way above that of similar sized peers Ensco (NYSE: ESV  ) and Transocean (NYSE: RIG  ) , which yield 5.4% and 4.7% respectively, many investors are right to question the sustainability of the payout.

Seadrill is one of the fastest growing offshore drillers, however most of this growth comes through debt-funded acquisitions and new builds. But this poses several questions: Will Seadrill be able to grow without acquisitions? How sustainable is the company's dividend? And should investors forgo Seadrill's high dividend for a stronger balance sheet that could be found elsewhere?

Let's start with the first of these questions: Will Seadrill be able to grow without additional acquisitions? To try to figure this out, I will be looking at return on invested capital. ROIC is a calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. ROIC gives a sense of how well a company is using its money to generate returns. Total capital includes long-term debt and common and preferred shares. If we compare this figure across the industry we can see how efficient each company is at turning invested capital into profits.

Crunching numbers
According to Marketwatch.com,, Seadrill's ROIC for the last twelve months has been 7.4% and Transocean's return has been a lowly 3%. However, Ensco has retuned an impressive 7.5%. This indicates that Ensco is actually achieving a better return for investors based on the capital invested in the business.

These figures also indicate that Seadrill's earnings growth during the past few years has been mostly down to its frenzied borrowing. What's more, as Ensco has not been borrowing as heavily as Seadrill to finance what we can now call, debt funded expansion, more cash hits Ensco's bottom line. For example, Ensco's net profit margin now stands at 28.3%, above Seardrill's reported 24.7%.

With over a billion dollars in quarterly revenue, these few percent are costing Seadrill and its investors tens of millions of dollars per quarter.

Digging deeper
This brings us onto the next question: how sustainable is Seadrill's dividend? To assess this, I want to use the funds from operations metric, which differs from the net operating cash flow metric as it does not include changes to working capital, and I believe that it is a more telling indicator of the company's ability to fund its dividend.

So how does Seadrill look? Well, during the last twelve months, Seadrill has generated $1.3 billion in cash from operations. However, during the same period the company has paid out $1.4 billion in dividends. This does imply that the company is having to draw cash from other areas aside from the cash generated from operations to pay the dividend .

In comparison, for the same period, Ensco generated $1.9 billion in cash from operations, from which it paid out $440 million in dividends. Furthermore, Transocean generated $2.8 billion from operations during the same period and paid out $1.12 per share in dividends, a total of $404 million.

Rounding up
So, all in all it would appear than not only is Ensco just as efficient as Seadrill with less leverage, but Ensco also has a more secure dividend payout. That being said, I'm not saying Seadrill's dividend is about to be cut, or the company is going to become insolvent anytime soon. However, for investors who are seeking a well-covered dividend payout and a sector leading return-on-invested-capital, Ensco may be the better choice over Seadrill, especially considering Seadrill's debt.

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Read/Post Comments (5) | Recommend This Article (3)

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  • Report this Comment On January 02, 2014, at 1:16 PM, PropioFurbo wrote:

    I would have never guessed from reading this article that Rupert owned shares in Ensco. Such a well balanced and unbiased assessment of the 3 companies (ESV, RIG and SDRL).

  • Report this Comment On January 02, 2014, at 1:16 PM, yokod1 wrote:

    Nicely done article. I've been long SDRL for quite some time in a tax-sheltered account. I would add that SDRL, a Norwegian company, is incorporated in Bermuda, hence avoiding that pesky Norwegian withholding on divis.

    Again, very nicely done and thanks.

  • Report this Comment On January 03, 2014, at 2:55 AM, awallejr wrote:

    I'm with PropioFurbo. His sarcasm is appropriate.

  • Report this Comment On January 03, 2014, at 3:34 PM, elvislevel wrote:

    Nothing like a listing of old, well known facts on SDRL to get the kool-aid drinking trolls out of the woodwork. SDRL is Frontline II. I would not touch it with a 10 foot pole.

    ESV is British, so should have zero withholding too.

  • Report this Comment On January 09, 2014, at 10:43 AM, 67Bulldog67 wrote:

    yokod1,

    For US taxpayers, there is no Norwegian withholding tax on SDRL's dividend. SDRL is technically based in Bermuda. Transocean, and until recently, Noble Corp., were Swiss based companies and got around paying Swiss withholding taxes on dividends by paying them out of retained capital. If fact, since NE will be raising their dividends meaningfully later this year, I believe that is one of the main reasons the company just relocated from Switzerland to the UK.

    As to elvislevel's comment comparing SDRL to Frontline, we have seen this comment by him before. He misses one major point - Frontline was operating in a much greater cyclical business with much shorter contracts, so when the shipping business turned down, they were immediately hurt. While the offshore drilling industry is certainly cyclical, I believe the UDW part has become a cyclical growth industry with a much longer life span. SDRL's longer term contracts, combined with the fact that they have the newest, safest, and most capable fleet in the industry, will greatly insulate them if the market softens.

    Now as to the author's comment regarding ESV's ROI being higher than SDRL's, he is correct. However, I would argue that if a company does not spend much to upgrade their fleet, their ROI will be higher than it would have been otherwise. While ESV in recent years is starting to upgrade their fleet, they have a very long way to go to match SDRL's number of modern floaters and JU's. With 2 to 4 years required to get a new build rig completed and earning cash, I would expect to see SDRL's ROI pass that of ESV in the relatively near future.

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