I've had my eye on Seadrill (NYSE:SDRL) for some time now. The company pays a very tempting dividend, currently at just over 9%. However, as I drilled down deeper into the company and the industry, it became pretty clear to me that it offered a compelling long-term investment opportunity.
Last year marked the best year ever for deepwater and ultra-deepwater discoveries. Not only did the energy industry's 52 finds smash the old record by 40%, but those discoveries were spread across the globe off the coasts of 14 nations. As good as last year was, 2013 is shaping up to be a gusher as well.
Just last month ConocoPhillips (NYSE:COP) and its partners announced two discoveries in the Gulf of Mexico. ConocoPhillips is planning to drill five exploration and appraisal wells this year, but that plan could be expanded by three more wells. Given its success, it wouldn't be a surprise if the company devotes more capital to its deepwater projects.
That's what is so compelling about Seadrill's future. The more oil that's discovered, the more it will incentivize energy companies to drill. That, of course, creates higher day rates for Seadrill's rigs which equates to more profits. It's a cycle that's showing no signs of slowing down.
While I really like Seadrill's outsized dividend, that's not the main reason why I'm choosing the company. The company is in the midst of a major newbuild program which has 22 units expected to be delivered over the next few years. This fleet build-out gives the company the most modern fleet of all the offshore drillers. That's important because it means less downtime, which is something exploration and production companies really like.
Further, Seadrill has a contract backlog of $21 billion which goes a long way to securing its hefty dividend. When you put it all together, the company is poised to grow its EBITDA by 50% by 2015. However, the company is not without its risks.
The biggest risk in my mind is Seadrill's use of debt to fund its growth. While the contract backlog provides security, it's still a risk as debt has been known to be the weight that's sunk many businesses. However, Seadrill does have a plan to keep its debt it check.
One of the levers it can pull is to drop down assets into Seadrill Partners (NYSE:SDLP). The company has already identified several assets with contract lengths of more than five years that would be ideal candidates to sell into Seadrill Partners. This flexibility, when combined with the backlog, helps alleviate much of the pressure from the debt worries.
A final risk, and perhaps the company's greatest unknown, is that of disaster similar in size and scope to the one that hit BP (NYSE:BP) and Transocean (NYSE:RIG) in the Gulf of Mexico. Not only did the disaster have a devastating effect of the Gulf region but it also greatly affected the operations of both BP and Transocean. That's why the overall risk of a similar disaster for Seadrill or one of its competitors remains to something to watch, especially given the company's high debt load.
The Foolish bottom Line
Despite these risks, I'm convinced that deepwater drilling will continue to grow in importance. That means no shortage of opportunities for Seadrill to increase its contracted backlog, and its dividend in the future. One final note of full disclosure, I am writing puts to start my Seadrill position. While I have no problem buying shares at its current price, I wouldn't mind picking them up a little cheaper.
Fool contributor Matt DiLallo owns shares of ConocoPhillips. Matt DiLallo has the following options: Short Jul 2013 $35 Puts on Seadrill. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill and Transocean. 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.