Seadrill (SDRL +0.00%) is on the radar for many investors simply because of its hefty dividend yield. The company recently surprised the market by actually lifting its quarterly dividend by $0.02 to $1 per share. This move came at a time when concerns surrounding rig oversupply and lower dayrates continue to pressure drilling stocks.
A symbolic raise
The dividend raise is mostly a symbolic move to bring the dividend to a round number. The raise itself is minuscule and does not impact the company's ability to pay. Speaking about the dividend during the earnings call, Seadrill execs stated that future dividends depend on backlog additions, operational performance, and the market outlook. However, there is one more important thing to think about, and it's Seadrill's ability to refinance.
Seadrill greatly depends on its financing activities. Put bluntly, the company borrows to pay its dividend, which currently yields more than 10%. Meanwhile, Seadrill's operating cash flow is not big enough to cover its dividend spending and payments for new-build rigs.
That's why the company is very active on the financing front and uses all possible means, including secured and unsecured debt, term loans, and MLPs. So far, Seadrill has been very successful with this financial juggling. The latest success is the news on North Atlantic Drilling (NYSE: NADL), in which Seadrill maintains a 70% stake. North Atlantic Drilling just scored a big contract with Rosneft. North Atlantic Drilling will supply up to nine offshore rigs to Rosneft with a total commitment of 35 rig years.
Risky strategy
Seadrill's strategy leaves the company vulnerable to further rig-market downside should it occur. However, the fact that Seadrill relies heavily on its new-build rigs is a positive sign. As new-build rigs flood the market, the dayrates for older rigs are put under more pressure. The dayrate gap between the new ones and the old ones is likely to widen.
This is not good news for drillers with older fleets like Diamond Offshore Drilling (DO +0.00%). Diamond Offshore has already cold stacked four rigs that were built prior to 1980. The company has 14 more rigs that were built back in the 70s. This year, Diamond Offshore is taking delivery of three new rigs, while two more rigs were already delivered.
Seadrill has a significant number of rigs under construction. The company stated that it expects the market will improve in 2016 and is standing behind its words, as it has four ultra-deepwater drillships and three jack-ups scheduled for delivery in the second half of 2015. Importantly, these rigs have no contracts behind them. This fact has both advantages and disadvantages. If the market really improves closer to 2016, Seadrill will be able to negotiate better dayrates for its new-build rigs. If the market remains under pressure, Seadrill could have a hard time finding work for its rigs or must consent to lower day rates.
Bottom line
While some observers see immediate risk for Seadrill's dividend, I'm not one of them. The company has proved its ability to use all necessary financing means to ensure its financial stability. However, Seadrill carries significant risks going forward. The decisive moment will be closer to the end of next year, when a plethora of new-build rigs will be marketed.
