Seadrill Ltd's Momentum is Set to Continue

Seadrill's newly secured rig contracts will provide solid revenue potential, and give further cushioning for the company's huge dividend yield.

Bob Ciura
Bob Ciura
Apr 10, 2014 at 10:21AM
Energy, Materials, and Utilities

Seadrill (NYSE:SDRL), as well as other oil drillers like Diamond Offshore (NYSE:DO) and Transocean (NYSE:RIG), haven't gotten much love from investors lately. Seadrill's shares are down over the past 12 months, and only increased slightly in 2013 while the broader market rallied. Much of this is due to over-arching fears that the deep-water drilling industry is about to enter a soft period of reduced demand.

It's true that members of Big Oil are cutting capital expenditures as a result of unspectacular returns from new drilling projects. But investors would be making a short-sighted error not viewing Seadrill for what it is, which is a highly profitable company with a bright long-term future.

Recent developments bode well for Seadrill
To be sure, conditions are far from perfect for certain drillers, including Diamond Offshore and Transocean. Bearishness on these two companies is somewhat deserved. Diamond Offshore is encountering a rough patch marked by significantly higher capital expenditures. Its operating profit fell nearly 17% last year, due to stagnating day rates and a notable increase in drilling expenses. Going forward, Diamond Offshore's cost structure will come under further pressure, as it plans to double capital expenditures on fleet upgrades in 2014.

Meanwhile, Transocean whiffed on its most recent earnings report. Its cash flow fell nearly 30% last year, due to a settlement with the Department of Justice pertaining to the 2010 Macondo rig explosion. Even on a purely operational basis, though, Transocean unimpressed. Utilization and fleet efficiency fell in the most recent quarter, due to extended downtime on certain rigs. For instance, Transocean's utilization fell to 75%.

Seadrill had no such issues last year. Its cash flow from operations increased nearly 7% and was due to strong utilization rates. For example, Seadrill generated 94% utilization for its floaters and 98% for its jackups, indicating strong demand for its own rigs, while other oil drillers are seeing softening demand. While analysts are busily ratcheting down their earnings estimates for oil drillers, Seadrill is conducting business as usual.

Going forward, Seadrill's momentum should continue. That's because it recently announced it has secured new contracts for four separate jack-up units. The total revenue potential for these contracts, as well as a contract extension for a separate rig, is pegged at $300 million. Since Seadrill generated a little more than $4.8 billion in revenue all of last year, these contracts alone stand to boost revenue by 6%.

Plenty of financial flexibility to fund its dividend
Perhaps the best feature of investing in Seadrill is its massive dividend. Aside from its solid underlying growth, it offers investors a 11% yield that it actually increased after its fourth-quarter results. However, it's important to know whether a company can afford to pay its dividend, and that's especially true when a company has as massive a payout as Seadrill.

Fortunately, even with its huge dividend, Seadrill's annualized $3.92 payout represents just 71% of its diluted earnings per share last year. That represents a fairly comfortable payout ratio that should allow it to pay its shareholders handsomely while still investing in its business.

It's true that Seadrill doesn't expect to grow its dividend much for the foreseeable future. In its fourth-quarter earnings release, management stated that since its dividend yield towers above the yields of its competitors, future cash flows would be better served to upgrade its fleet and strengthen its balance sheet.

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Even so, investors shouldn't be scared away by the prospect of limited dividend growth over the next two or three years. Seadrill's 11% yield is excellent, particularly considering the overall investing climate. The yield on the broader market is only about 2%, and interest rates are still near zero. For investors looking for a solid blend of growth and income, Seadrill is a great pick.