Seadrill West Freedom Jack-Up. Source: 

Seadrill (NYSE:SDRL) provided a shock when it released its first-quarter earnings report last month. Many analysts expect a near-term slowdown in global oil drilling activity, based on the fact that major oil and gas producers are cutting back on capital expenditures due to falling returns on new projects. Conceivably, this would put a dent in demand for offshore rigs.

But Seadrill managed to increase its dividend after posting first-quarter earnings, despite previously warning investors not to expect a dividend increase. This raised some concerns that perhaps management is getting ahead of itself. Seadrill was already the highest-yielding in its peer group, so there was little urgency to raise the dividend.

With underlying financial results that were less-than-impressive, perhaps it's time for Seadrill to get a little more conservative with its financial management practices.

Look beyond the headline figures
Seadrill's earnings release looked like a whopper of a report. It posted $6.54 in earnings per share, which appears to be a huge performance, especially since the company generated $5.52 in EPS all of last year. But there are several one-time items that boosted Seadrill's earnings in the first quarter that need to be stripped out for a clearer understanding of its true performance.

First and foremost was a $2.3 billion one-time gain from a deconsolidation of Seadrill Partners (OTC:SDLP.F). Seadrill Partners is a growth-oriented company formed by Seadrill to acquire and operate rigs, which are secured under long-term contracts with oil and gas giants like Chevron and ExxonMobil. Seadrill holds a majority stake in Seadrill Partners, roughly 53% of the company.

In addition, Seadrill got a boost from asset disposals. The company realized a gain on the sale of the West Auriga. These disposals boosted operating profit by $316 million. On a consolidated basis, Seadrill's operating profit would have been $547 million in the first quarter, which would have actually represented a decline year over year.

Seadrill's core metrics didn't look outstanding in the first quarter. Several rigs suffered prolonged downtime. Seadrill's floaters posted a three percentage-point decrease in utilization versus the prior quarter. Utilization of jack-ups was flat.

Still, management was confident enough in the company's performance to raise its dividend to $4 per share annualized.

Confusing dividend increase
Seadrill already provided a nearly double-digit yield, which is way ahead of the industry average. And yet, the company increased its dividend again after first-quarter earnings, despite its underlying results coming in fairly soft. Even more confusing is that just three months ago, management made it clear to investors that its dividend was likely at its ceiling.

In Seadrill's fourth-quarter report, it stated: "Seadrill is currently trading at a yield of 10.4% based on an annual future dividend of $3.92 per share. In the current market, the Board sees limited value in increasing the current quarterly distribution beyond $0.98 per share."

Based on the company's true first-quarter performance, it doesn't seem like the company had the financial success that would warrant a dividend increase. This begs the question whether Seadrill is perhaps getting too aggressive with its dividend policy.

What concerns me is that Seadrill may not have enough financial cushion to sustain such a massive dividend if business conditions take a turn for the worse. Its balance sheet is fairly bloated. The company holds $10.7 billion in interest-bearing long term debt, which results in a long term debt to equity ratio greater than 100%. That's problematic, particularly if we are in a rising rate environment.

The bottom line is that Seadrill's dividend may prove to be too great of an anchor for the company. At $4 per share annualized, Seadrill's dividend is going to cost the company more than $1.8 billion per year. A 10% yield is great, but Seadrill is left with very little wiggle room. I think the company should focus on whether it generates enough cash flow to fund its newbuild program and keep its already huge dividend intact.