Yielding over 10%, offshore driller Seadrill (NYSE:SDRL) gets lots of attention nowadays for its hefty dividend. The biggest concern for most investors has been that the offshore drilling market isn't currently in the best shape, which is why Seadrill is down 13% year to date, but can its attractive yield now support the share price?
Drilling market looks dull
During its recent earnings call, Seadrill stated that the offshore drilling market suffers from reduced growth and cuts in capital spending from major oil companies. At the same time, new rigs continue to enter the market. Seadrill alone brought 13 new rigs to market in 2013.
The growth of rig supply, together with muted demand, pressures the dayrates for rigs, likewise putting pressure on drillers' margins. This effect is more pronounced for operators with older rig fleets, like Diamond Offshore Drilling (NYSE:DO). Diamond Offshore is trying to rejuvenate its fleet and has already received one of four newbuild ultra-deepwater drillships.
While drillers say that the market is currently oversupplied, some will build more rigs. Transocean (NYSE:RIG) expects that it will take 18-24 months for the market to recover but at the same time placed orders to build two new ultra deepwater drillships.
As often happens in oversupplied markets, companies wait for their peers to remove the excess supply while continuing to pursue their own plans. The result is the rise in supply that hurts every market participant.
But the key thing to watch is the financing market
As if its quarterly dividend wasn't big enough, Seadrill recently raised its distribution by $0.03 per share to $0.98 per share. The company stated that the dividend increase reflected the improvement in operational results, solid order backlog, and strong support from the financing markets.
In my view, the most important part of the equation is the financing support. Seadrill pursued a very aggressive growth strategy, seeking financing to build more rigs. As a result, the company's total debt has grown to $13.9 billion.
Seadrill has 20 rigs under construction, for which it must pay $6.3 billion. This means that Seadrill will continue to be very active in the debt markets. What's more, the ability to refinance at reasonable rates is the key to Seadrill's growth.
So far, the debt market has been favorable for Seadrill. However, if the decline in drilling activity lasts for a longer time than expected, Seadrill could face problems. The company already decided not to order additional rigs until the market shows signs of recovery, realizing that it's unwise to flood the stagnant marketplace with more supply.
Seadrill stated that it had contracts for 96% of its fleet in 2014 and for 66% in 2015. So far, the company has been successful in marketing its assets. In comparison, Transocean's fleet utilization was 75% in the fourth quarter.
In the short term, there's little threat to Seadrill's dividend. That said, the dividend will provide support for Seadrill's shares. The yield is attractive, and it will limit the downside if the outlook for offshore drilling worsens. In the long term, it is the availability of financing that matters, especially if the market stagnation lasts longer than two years.
Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill and Transocean. 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.