The 3 Best Offshore Oil Drillers for High-Yield Investors

Offshore oil drilling is one of the most powerful mega-trends of the next few decades. Due to short-term industry weakness, income investors have a chance to lock in safe, high yields that are likely to grow strongly for many years to come.

May 15, 2014 at 2:53PM

Editor's note: A previous version of this article referenced Noble Energy (an onshore E&P company) rather than Noble Corp (the offshore driller). The Fool regrets the error.

According to a study by Morgan Stanley and Rystad Energy, by 2035 the world's oil demand will increase by 13%-26%, causing prices to increase to $125/barrel-$150/barrel. 

To meet the massive demand in the face of aging and depleting land-based oil fields, oil companies are having to increase their E&P (exploration and production) budgets enormously. In 2013, total global E&P spending was almost $650 billion. To put that into perspective, according to the CIA world factbook, in 2012 the entire global economy was $85 trillion. This means that $1 of every $130 in the world is spent on finding and producing oil. 

The location of new oil fields is the key to this article and the investment opportunities it presents. Between 2012 and 2030 conventional, land-based oil production is expected to grow at just  a 1% CAGR. In contrast, ultra-deepwater production will grow at a 19% CAGR. 

Recently a series of negative articles and opinions by Wall Street's leading analysts have maximized negativity about the offshore drilling industry: 

  • An article in Barron's argues that oil will fall 25% to $75/barrel over the next five years.
  • Barclays predicts up to 40% downside for offshore oil drillers due to a glut of new rigs causing plummeting day rates.
  • Morgan Stanley and Citigroup predict falling day rates over the next two years will cause a collapse in the stock prices of offshore drillers.
This article is meant to show why these negative views of the offshore oil drilling industry are short-sighted and why now is the time for income investors to load up on cheap shares of the best offshore drillers. 
 
Why the analysts are wrong
In order to satisfy the demand for ultra-deepwater oil production in 2020, the world will need 455 ultra-deepwater (UDW) oil rigs. This is 165 more than exist now or are scheduled to be built. 
 
Thus the concerns over falling day rates due to a short-term glut of new UDW rigs is misguided because by 2016-2017 global demand will have easily absorbed the new supply. This will keep day rates high for the most advanced rigs. My favorite offshore driller exemplifies this point.

Seadrill (NYSE:SDRL) has a fleet of 49 rigs (34 UDWs), with another 20 to be delivered by 2016 (11 UDWs). With the most modern UDW fleet in the world (average age 3.2 years), concerns over falling day rates shouldn't apply to Seadrill. Ten out of Seadrill's eleven latest UDW contracts have been for higher day rates, including its highest rate ever ($653,000/day) signed in the fourth quarter of 2013.

With an almost 12% yield that even Barclay's calls "rock solid" and the stock trading at just eight times cash flows (25% below historical average), Seadrill is massively undervalued. In addition, management has recently undertaken a balance sheet strengthening plan to secure the dividend (and grow it gradually during the short-term weakness) while paying down debt.

Combine this with the 20% CAGR EBITDA growth management is projecting through 2016 (due to the fleet growth) and you have the potential for a great investment over the next decade, combining an already sky-high yield with the potential for dividend growth and substantial capital gains. 

Ensco plc (NYSE:ESV) is my second favorite offshore oil driller for two key reasons.

First, it has the second most modern UDW fleet in the world (average age 3.9 years) with six new rigs to be delivered by 2016 (three of them UDW). Unlike Seadrill, which finances its new rigs with cheap debt, Ensco likes to mostly fund new rigs with cash flow -- a major reason why it has the lowest leverage ratio in its industry (27%).

In addition to a fast growing, super-modern UDW fleet, Ensco has the second highest yield in the industry -- 6%. With a payout ratio of 49% and cash flows predicted to grow by 12% annually, this dividend is not just safe but likely to grow in the future.

Noble Corp (NYSE:NE) is my third favorite offshore driller for three reasons.

First, the yield of 5% is the third highest in the industry, yet represents only a 25% payout ratio. 

Second, cash flow growth after 2015 (due to completion of its new build program) will fund dividend growth. 

Finally, it's spinning off standard rigs into a separate company (Paragon Offshore), leaving Noble a pure premium rig play. This will minimize exposure to short-term day rate weakness and further secure the dividend.

In addition, the Paragon IPO (summer 2014) will likely see Noble sell 20% of Paragon, resulting in further liquidity to pay down debt, secure the dividend, and grow it in the future.

Foolish takeaway
The current concern over offshore oil rig day rates is greatly overblown. The current price weakness is a terrific opportunity for long-term income investors to cash in on one of the strongest megatrends of the next few decades and achieve the trifecta of investing: high yield, fast growing dividends, and superior capital gains.

Cash in on rising spending in the energy industry
Imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!

 

Adam Galas owns shares of 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers