Can Seadrill Increase Dividends and Service Debt?

Seadrill (NYSE: SDRL  ) has increased its quarterly dividend payout to $1 per share in the first quarter of 2014 from $0.75 per share in 1Q 2011. During the same period, the company's debt has swelled to $12.4 billion from $9.8 billion. This article discusses why Seadrill can continue to increase dividends and service debt comfortably.

For the first quarter, Seadrill reported a pro forma consolidated EBITDA of $788 million and a cash interest outflow of $122 million. This translates into an EBITDA interest coverage ratio of 6.5, which implies that debt servicing is not a concern.

The second positive factor is the existing contract backlog for floaters and jack-ups. The company's floaters are 96% contracted for 2014 and 66% contracted for 2015. The jack-ups are 97% and 73% contracted for 2014 and 2015 respectively. The conclusion from this point is that the EBITDA will continue to remain firm, and so will the EBITDA interest coverage.

Seadrill also has a strong operating cash flow and the company's cash flow covers for the dividend payment as well as the debt servicing. For the first quarter, Seadrill reported an operating cash flow of $656 million. Considering a dividend payout of $1 per share, the total dividend outflow works out to $469 million. Therefore, Seadrill can service debt and pay the current level of dividends from the operating cash flows.

From a debt increase perspective, it is important to mention that as of the first quarter of this year, Seadrill had 19 new vessels for delivery with remaining yard installment of $5.4 billion. While the addition of new vessels will increase the debt, the new vessel will also have an incremental impact on the EBITDA and cash flow.

On a relative basis, Seadrill's growth trajectory is likely to be the best as compared to peers. As of the first quarter, Seadrill had 19 new vessels scheduled for delivery over the next few years as compared to eight new vessels to be delivered for Ensco (NYSE: ESV  ) and twelve new vessel deliveries for Transocean (NYSE: RIG  ) . While both these peers have low leverage compared to Seadrill, I consider leverage-backed growth positive as long as debt servicing metrics are under control (as is the case with Seadrill).

Another important point to highlight here is the new development related to North Atlantic Drilling (NYSE: NADL  ) , which can potentially result in cash inflow for Seadrill. North Atlantic Drilling and Seadrill have signed an investment and co-operation agreement with Rosneft in May 2014.

As part of the agreement, North Atlantic Drilling will enter the onshore drilling market in Russia and enter into contracts for multiple offshore assets. In addition, Rosneft will be acquiring a significant equity stake in North Atlantic Drilling with Seadrill still retaining majority shareholding.

Even if Seadrill reduces its stake in North Atlantic Drilling by 20%, there is a potential cash inflow opportunity of $532 million for Seadrill. This can be used to reduce debt or pursue growth opportunities.

In conclusion, Seadrill still has some bandwidth to increase the dividend payout along with comfortable debt servicing. With a firm order backlog, the dividend visibility remains secure in the foreseeable future. The company's debt is likely to increase further with 19 new vessels to be delivered over the next three years. However, this is certainly not a cause for concern as the company's EBITDA and operating cash flow will also witness incremental growth with the addition of each new vessel.

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