Key Takeaways From This High-Yielder's Earnings

North Atlantic Drilling has a strong contract position that should allow it to weather any market difficulties in 2014. In addition, the growing demand for the company's rigs from areas such as Russia and Norway should allow it to secure contracts for the years following 2014.

Mar 11, 2014 at 3:07PM

North Atlantic Drilling (NYSE:NADL), an offshore drilling contractor specializing in drilling wells in the harsh environments of the North Sea, Norwegian Continental Shelf, and Arctic, announced its fourth quarter 2013 results on February 25. This announcement was made in conjunction with its parent company Seadrill's (NYSE:SDRL) fourth quarter results.

Seadrill owns 70% of the outstanding shares in North Atlantic Drilling, a position that gives it majority control of the company. This report also marks a milestone for the company as it is the first earnings report that North Atlantic Drilling has issued since becoming listed on the New York Stock Exchange. This announcement serves quite well as North Atlantic Drilling's inaugural report as it shows the company's stability in the face of the difficulties that still surround the offshore drilling industry.

North Atlantic Drilling showed a considerable amount of quarter-over-quarter stability in its latest earnings report, which is something that is likely to provide some comfort with the company's ability to maintain its high dividend yield. This dividend, which was increased to $0.23 per share per quarter as a part of the company's earnings announcement, currently gives the stock a yield of 10.55%.

It may seem strange that the company increased its dividend given that its revenues and operating profits declined slightly on a quarter-over-quarter basis, but this decline was just due to normal fluctuations and not any weakness in operations.  The company's revenues declined from $321.2 million to $310.4 million in the latest quarter. This caused earnings to decline to $89.2 million. However, the company also showed several reasons to be optimistic about its future prospects in this report.

Increased downtime
One of the first things that you may notice when reviewing the highlights from the quarter is that the company's revenues and profits both dropped slightly on a quarter-over-quarter basis. However, this is nothing to worry about because it can easily be explained by normal fluctuations that are common in the industry.

In the fourth quarter, North Atlantic Drilling had an economic utilization rate of 95%. However, in the third quarter, the company had an economic utilization rate of 96%. This means that North Atlantic Drilling incurred slightly more downtime in the fourth quarter than in the third. Because the oil companies that hire offshore drilling rigs do not pay the contractor for downtime, revenues (and by extension, profit) will naturally decline when the company incurs more downtime.

Strong contract position provides safety
North Atlantic Drilling appears to be well-positioned to weather market weakness in 2014 and into 2015. North Atlantic Drilling states in its report that it has no rig availability in 2014. This means that every one of the company's drilling rigs has a contract that lasts until the end of the year. Therefore, North Atlantic Drilling doesn't need to worry about finding new contracts for any of its rigs this year.

This should provide safety and reassurance for investors who are concerned about the market's shift from one of being undersupplied to one of adequate supply. This also allows the company to fairly accurately predict its revenue and cash flow for this year because it is contractually obligated to receive all of its revenue this year.

This situation changes somewhat in 2015, but there is still nothing for investors to worry about. The company's quarterly report states that 73% of its fleet is covered under firm contracts in 2015, as shown in its fleet status report: 

North Atlantic Drilling Fleet Status Report

Source: North Atlantic Drilling

As you can see, three of the company's rigs will have at least some availability in 2015. North Atlantic Drilling's only drillship, West Navigator, will come off contract in December 2014. The company also has two harsh-environment semisubmersibles, West Phoenix and West Venture, that will come off their existing contracts in June and July 2015, respectively. If North Atlantic Drilling fails to secure new contracts for these rigs then it could lead to a precipitous drop in the company's revenues and profits.

Growing demand in Norway and Russia
North Atlantic Drilling's management clearly doesn't foresee this becoming a problem. One reason for this is that demand for offshore drilling rigs has grown rapidly in the company's largest market of Norway over the past several years. From 2008 to 2013, the Norwegian rig fleet has grown at a rate of 14% per year, from 17 to 25 rigs. However, the rate of oil production in the country has declined 18%. This illustrates that an increasing number of rigs are needed to produce oil in the country.

Meanwhile, Norway has seen a few discoveries of oil in some of its harshest regions over the past few years. Two of these discoveries are Johan Sverdup in the North Sea and Johan Castberg in the Barents Sea. As these two fields, among numerous others, are developed, the country will likely demand more offshore drilling rigs, and North Atlantic Drilling is well-positioned to supply these rigs due to its position as the largest provider of harsh environment-capable offshore drilling rigs in the world.

The company's management also sees more demand for rigs coming from Russia. This is due to the desires of the giant oil companies located in the country to develop resources in the Barents Sea. Additionally, the companies that are license holders on the Russian Arctic Shelf are required to drill a total of one hundred wells over the 2014 to 2024 period in order to retain their licenses. North Atlantic Drilling is going to be the first mover into this area by drilling two wells for ExxonMobil and Rosneft in the summer of 2014. The company may be able to secure contracts for the three rigs that are coming off contract in 2014 and 2015 by leasing them to the oil companies that need to drill on the Russian Arctic Shelf in order to retain their licenses.

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Daniel Gibbs has long positions in North Atlantic Drilling and Seadrill. His research firm, Powerhedge LLC, has a business relationship with a registered investment advisor whose clients may have long positions in any of the stocks mentioned. Powerhedge LLC has no positions in any stocks mentioned and is not a registered investment advisor. 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.

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