Don't Write off Seadrill Ltd

Many retail investors and analysts alike are concerned about Seadrill's dividend vis-a-vis the company's debt and free cash flow. However, when we take a more holistic, 'big picture' look at the company, it becomes apparent that Seadrill is merely taking a calculated risk.

May 6, 2014 at 11:37AM

In an article written on April 30, fellow Fool Rupert Hargreaves raised some concerns associated with Seadrill (NYSE:SDRL) and the company's dividend policy. The article included this comment from a Wells Fargo analyst:

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.

The author went on to cite that dividends well exceed free cash flow and are causing a large shortfall. While at first glance this may look alarming, when you dig deeper into Seadrill's operations, it becomes apparent that the company is in a transitory phase. Seadrill has engaged in an ambitious plan to provide the most modern fleet in the market. Once Seadrill finishes or even pauses its rig-building program, its finances will look very different from how they look now. 

While Hargreaves certainly wasn't wrong in stating the facts, I believe that a 'bigger picture' view will better convey my point about Seadrill's transition.

Sdrl Ocfery

Source: Morningstar

The above two charts, I believe, give an accurate 'big picture' view of Seadrill's finances over the last five years. Look first at the left-hand chart. Operating cash flow, or OCF in the chart, has consistently been higher than the company's dividend payments. 

Adequate operating cash flow, however, is no guarantee of a safe dividend. Ideally, dividends should be paid from free cash flow, which is operating cash flow less capital expenditures. Free cash flow, therefore, represents the company's cash flow minus the spending allocated into growing the business. The chart on the right hand side above represents operating cash flow and capital expenditures. Since 2010, Seadrill has outspent its own cash flow, meaning that it has had negative free cash flow for most of these years.



This capital spending, however, is to build a larger, newer, more ultra deepwater-oriented fleet, including ships such as the West Auriga shown above. After the Maconodo accident in 2010, operators have preferred to lease newer rigs with updated safety specifications. Furthermore, the majority of offshore discoveries have been at depths greater than 7,500 feet below sea level, or at 'ultra-deepwater' depths.

Therefore, it makes sense for Seadrill to be building a new, deepwater fleet, which operators will pay a premium for. The results already speak for themselves too: Seadrill's floater utilization rate is near 100% and is consistently higher than that of its peers. 

Bottom line
By focusing on just one metric it's easy to take things out of context. Yes, Seadrill has negative free cash flow and is paying a large dividend. But looking at things holistically, this situation is a concern only if you don't believe that Seadrill's new build program will not pay off.

I believe that it will, and I would argue that it already is. There's no doubt that Seadrill's strategy of taking out debt to ambitiously build deepwater ships is a bold one, but it is a move that is grounded in solid thinking. In other words, Seadrill is a calculated risk. 

3 stock picks to ride America's energy bonanza
Record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 

Casey Hoerth has no position in any stocks mentioned. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information

Compare Brokers