Seadrill Ltd (NYSE:SDRL) recently reported a pretty decent quarter. Its financial metrics were pretty good and its utilization rates were strong. However, the company did throw water on the idea that the slowing offshore market was going to rebound quickly, instead it noted that it believes we're heading for a bigger slowdown in the offshore drilling market. That rattled investors who promptly sold off its stock. However, I see three reasons why that wasn't a good idea.
Management is confident in the dividend
Seadrill gave a big show of support for its dividend by raising it by $0.03 on the quarter to $0.98 per share. That dividend isn't likely to be cut. The company noted that its order backlog, which stands at $20.2 billion, "provides clarity for future earnings as well as generates visibility for dividend capacity." Further, the company noted that it's "highly confident that the dividend is sustainable in the coming years."
The company noted that it has faced rough seas before in 2008. However, because of its contract backlog Seadrill "sailed through this cycle with limited loss of earnings due to solid contract coverage." The company also noted that the risks facing it and the industry are significantly lower than those in 2008. So, while the market might not be robust, its not going to be a bust either.
Seadrill Partners as a funding source
One of the reasons Seadrill is confident in its dividend is due to the ability to drop down assets to Seadrill Partners LLC (NYSE:SDLP). Just this past quarter the company sold the tender rig T-16 to Seadrill Partners for $200 million. On top of that it sold part of two semi-submersible rigs to Seadrill Partners as part of a $456 million deal. The company can continue to sell assets to Seadrill Partners in order to maintain its own financial flexibility as well as strengthen its dividend.
One reason for this is that Seadrill noted that its plan is to use 20% of any net proceeds from drop downs to Seadrill Partners to create additional dividend capacity. The target will be to return these funds to shareholders within 12 months of the release of the funds. However, the company also noted that it sees "limited value" in boosting its dividend beyond the current $0.98 per share each quarter. Therefore, it's likely to use this additional capacity to buyback stock, which will reduce its cash outlay initially. From there the company can increase its dividend per share, while keeping the cash outlay static. In addition to this the company could also use the funds for future increases as well as for an in-kind dividend.
Opportunity grows with uncertainty
Seadrill's strong contract backlog has already locked in a growth rate in excess of 20% for 2014. Because of this as well as its strong access to capital the company believes that is has the opportunity to capitalize on the weaker market outlook. For example, Seadrill believes that it can pursue merger and acquisition opportunities as well as individual asset purchases.
Just this past quarter the company bought a company that owns the yard construction contract for a newbuild high specification jack-up rig. Seadrill paid $235 million and will invest another $250 million to get the rig ready to drill. Again, because of Seadrill's financial flexibility it can continue to buy assets like this at attractive rates.
Seadrill investors have likely seen the last dividend boost for a while. However, the current rate is not only safe, its growing more secure thanks to the company's plan to set up a fund from the proceeds from assets dropped down to Seadrill Partners. Further, the company is well positioned to capitalize on this current downturn, so while the near term outlook might be disappointing the long-term potential remains pretty compelling.
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Matt DiLallo has the following options: short April 2014 $38 puts on Seadrill. The Motley Fool recommends Seadrill. 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.