Seadrill (NYSE: SDRL ) and Transocean (NYSE: RIG ) have been two of the market's worst-performing stocks year to date, as almost every set of analysts on Wall Street has turned negative on the offshore drilling sector.
Indeed, it is widely believed that the offshore drilling industry is about to enter a cyclical slowdown, putting pressure on earnings across the industry. Unfortunately, this implies that dividend payouts of companies within the sector could also come under pressure.
Now, Seadrill's dividend is and has always been the subject of much speculation and analysis (I have looked at the sustainability of the payment many times myself), and many conclusions have been drawn.
However, research notes from analysts at Wells Fargo published by Barron's recently caught my attention. The note raises some interesting points and brings into question the sustainability of Seadrill's dividend payout with the upcoming slowdown looming. The note states:
It has long been our analysis that [Seadrill's] aggressive dividend policy has never been funded solely by the operations of its high-quality fleet, but instead has been funded through the sale of i) equity and convertible debt ii) equity in sponsored "child" entities ([North Atlantic Drilling (NADL), Seadrill Partners (SDLP)]), and iii) the outright sale of rigs ... As long as [Seadrill] could sell these assets and equity for premium prices, it could sustain a high dividend ... asset values are slipping, we think [Seadrill] may fail to secure the sales prices and external financing required to sustain its current dividend.
This raises a valid point. In particular, looking at Seadrill's cash flow figures supplied by the company within SEC filings, during the past four years, cumulative free cash flow has amounted to just under -$3 billion and dividends paid out during the period have amounted to $5.6 billion, which leaves an $8.6 billion shortfall.
For the most part, this shortfall has been met with debt issuance, $7.5 billion to be exact and last year, $1.3 billion was raised through the sale of assets. So, it would seem that Wells Fargo's analysts have a valid point.
Hiking the payout
Meanwhile, Seadrill's industry peer, Transocean, is planning to hike its dividend to $3 per share this year and is moving to reassure investors that the higher payout is sustainable.
Transocean's management has stated that the company is looking to stabilize the balance sheet through the sale of non-core assets, mainly old floaters. Additionally, the company is planning to spin off or convert a portion of its business into an MLP-like vehicle, including some of the company's best and newest rigs-- similar to the strategy Seadrill is using.
What's more, Transocean plans to boost margins in order to free up an additional $500 million by the end of 2015.
But overall, with 361 million shares in issue, a dividend payout of $3 per share will likely cost Transocean slightly under $1.1 billion per annum. The company's cash flow from operations has averaged $2.6 billion during the past four years, which gives plenty of cover.
All in all, while no analysts can predict the future, the guys at Wells Fargo have a point about Seadrill's dividend sustainability. With a drilling sector slowdown on the horizon, it's better to be safe than sorry, and on this basis, Transocean's well-covered dividend payout and the company's plans to increase profits indicate that the company's dividend is more secure than that of Seadrill.
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