2 Offshore Drillers That Are Not on Most Investors' Radar

Diamond Offshore and Seadrill Partners aren’t the most talked about offshore drillers, but both offer intriguing profit potential for investors.

Jul 11, 2014 at 2:40PM

Seadrill (NYSE:SDRL) is one of the most popular offshore drillers in the investment world. Handing shareholders a huge dividend each quarter will certainly add points to any company's popularity score. However, while investors are drawn to Seadrill's massive 10% yield, they are turning a blind eye to large payouts from Seadrill Partners (NYSE:SDLP) and Diamond Offshore (NYSE:DO). Both companies are flying under the radar, suggesting that either could be a profitable opportunity for investors.

Drilling down into Seadrill Partners
There are two big reasons why Seadrill is more popular than its master limited partnership, Seadrill Partners. The fact that Seadrill controls Seadrill Partners' growth is one key reason why investors are likely to choose the parent company. Seadrill Partners' yield is also just over 6%, significantly lower than Seadrill's 10% yield. But Seadrill Partners' payout has a lot of room to grow.

West Auriga Small

The West Auriga drillship, which was recently dropped down to Seadrill Partners from Seadrill. Source: Seadrill Partners. 

Seadrill Partners' future growth will be fueled by drop-down transactions from Seadrill. Just last quarter Seadrill sold a 51% interest in the West Auriga drillship to Seadrill Partners. The addition of that vessel is expected to enable Seadrill Partners to increase its distribution by a $0.13-$0.15 annual rate. That's on top of the most recent 14% increase. Further drop-downs between Seadrill and Seadrill Partners will allow for future distribution increases. So while Seadrill Partners' payout is currently smaller than that of its parent, this might not always be the case.

A Diamond in the rough?
Many investors also pass by Diamond Offshore's dividend at first glance. Based on the company's quarterly dividend rate, Diamond Offshore's yield is just above 1%. That's certainly not high enough to tempt yield seekers, but investors might be overlooking the fact that Diamond Offshore sends its investors much higher special dividends each quarter. For the past few years the company has sent $3 per share in special dividends to investors, compared to just $0.50 a share in regular dividends. Add up the two payments and Diamond Offshore offers a much more compelling yield of 7.29%. In fact, as the following slide shows, Diamond Offshore is the best contract driller when it comes to returning capital to shareholders.

Diamond Offshore Divs

Source: Diamond Offshore Investor Presentation (link opens a PDF).

That said, there are some reasons to worry about Diamond Offshore, as the company has a lot of contracts rolling off this year without replacements in sight, which could impact its dividend. However, if the company can get past that storm its payout should be in good shape. Among the reasons for optimism are the five newbuilds under construction that should bring the company's total fleet to 45 offshore drilling rigs. Furthermore, Diamond Offshore has lots of room on its balance sheet to grow, as its net debt-to-market cap is just 3%; for comparison, Seadrill's is nearly 50%. Diamond Offshore is the only drilling contractor with A-rated debt, so it certainly has plenty of dry powder to expand its fleet once the troubles in the deepwater market subside.

Investor takeaway
While the yields offered by Diamond Offshore and Seadrill Partners are smaller than the ultra-popular Seadrill, both companies offer lots of room for future income growth. Both could end up being better income stocks over the long term than Seadrill. Right now most investors don't see that future, which is why these two offshore drillers continue to fly under the radar. 

Do you know this energy tax "loophole"?
Seadrill Partners has one more reason why its payout could exceed Seadrill's in the future. As an MLP it is taking advantage of a tax "loophole" that's designed to put more money into the pockets of investors. It's a loophole you really need to know. You can take greater advantage of this profitable opportunity by grabbing our brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Matt DiLallo 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.

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