For dividend hunters, there is now a new kid on the block: Transocean (RIG 1.55%). Two weeks ago, Transocean's board put forward a proposal that the company pays a full-year $3 per share dividend in four quarterly installments throughout 2014. This proposal is still to be voted through at the AGM. At current levels the $3.00 annualized dividend payout is equal to a yield of around 7%, 3% less than the yield on offer from Seadrill (SDRL) and approximately 1% more than the yield of 5.9% currently offered by Ensco (VAL). But should investors question whether or not this payout increase is going to hurt the company in the long term? Indeed, Transocean's fleet of drilling units is getting old, and it's debatable whether or not the company should be paying this additional cash out to investors, or reinvesting it to improve the quality of its assets.
Transocean needs to keep up with industry trends
According to many offshore drilling industry analysts, the offshore drilling market is slowing down, and it is widely believed that, as a result of this slowdown, the day rates for ultra-deepwater, or UDW, drilling units will drop by around 16% over the next few years. Unfortunately, in the worst case, Barclays believes that earnings before interest, taxes, amortization, and depreciation forecasts over the next two years will be up to 35% lower than originally forecast for some drillers.
Nonetheless, there is a bright spot. Deepwater drilling is set to dominate the oil exploration and production industry over the next decade. Data from analysts at Wood Mackenzie predicts that the size of the deep-water drilling market is expected to hit $114 billion by 2022, up from $43 billion by 2012.
Effectively, this means that drillers with the newest UDW capable fleets are well positioned to profit over the next few years, and this is where Transocean falls behind. For example, over 90% of Seadrill's floater fleet is UDW capable, and 100% of the company's jack-up fleet is able to drill past 350 ft. However, less than 50% of Transocean's floater fleet is UDW capable. So, despite being the largest offshore driller, Transocean has some catching up to do.
And that's not all. Another important emerging trend for the offshore drilling industry is the need for high-spec, new drilling units with the capability to drill faster and in a safer way than before. Newer drilling units usually have more high-tech equipment and are more desirable. The average age of Seadrill's floater and jack-up units is approximately five years. Meanwhile the average age of Transocean's fleet is closer to two decades -- this is the most concerning factor.
Wouldn't the cash be better used elsewhere?
So, with Transocean's fleet looking to be at a disadvantage when considering industry trends, it is a surprise to see the company increasing its payout to an aggregate $1.1 billion per annum. Wouldn't this cash be better spent renewing the company's drilling fleet?
Further, it's not as if Transocean has that much cash to throw around either. Full-year 2013 number are not out yet, but the company only generated $1.2 billion in cash from operations during the first nine months of last year. Of this $1.2 billion, Transocean spent $1.3 billion on capital assets, so Transocean is already overspending.
That being said, it would appear that, fiscally, Transocean is in a stronger position than peer Seadrill to offer investors this higher dividend payout.
What I'm talking about here is Seadrill's rising debt pile. This is somewhat of a double-edged sword, as while Seadrill is building up its fleet with newer drilling units to position itself well for offshore drilling market trends, the rising level of debt could come back to haunt the company if interest rates rise.
Based on third quarter numbers, the most recent available for all companies concerned, Seadril's debt-to-equity was 190%, Transocean's was 62% and Ensco's was closer to 38%. Still, Seadrill's borrowing has given the company one of the newest, UDW-capable, high-spec fleets in the world. However, is Seadrill making the right decision by borrowing?
Is borrowing the right idea?
We can evaluate whether or not the company is right to take on this excessive level of debt using the return on invested capital, or ROIC metric. Essentially, ROIC allows us to evaluate how well each company is deploying this debt to achieve a return for investors. Ensco's ROIC is 8.3%, Transocean's is only 3%, and Seadrill's comes in at 7.4%. With this information it becomes apparent that Ensco's lower level of leverage is not costing the company money -- in fact it is the opposite.
So, in conclusion, Seadrill is well positioned for emerging trends in the offshore drilling market, but Transocean's move to pay out more cash to shareholders could impact future performance. With this being the case, it might be an idea to avoid Transocean despite its new, attractive dividend yield and look for opportunities elsewhere.