Noble Corp plc (NYSE:NE) recently gave offshore drilling investors some bad news when it provided its latest fleet update. While the company was able to get the Danny Adkins rig in the Gulf of Mexico signed to a new contract, that contract was for just $317,000 per day. This was well below its previous day rate of $498,000 and well below the just under $400,000 day rate analysts were expecting. Given that the high dividend payouts of offshore drilling companies like Noble Corp, Seadrill Ltd (NYSE:SDRL), and Transocean Ltd (NYSE:RIG) are funded by high dayrates, it certainly makes investors wonder if those dividends are in trouble.
Offshore drilling's bad year could get worse
Prior to Noble Corp's disappointing fleet update, Seadrill offered up its own bleak outlook for the next two years. The company's CFO said that the offshore drilling market would be "bad" this year and "worse" next year before stabilizing. The issue is the fact that day rates for offshore drilling rigs have fallen sharply over the past 18 months as oil companies are cutting back spending because of weak profits. This is at a time when a number of new rigs are hitting the market, causing it to become oversupplied.
That being said, this is not the end of the world for offshore drilling contractors. Even after announcing a below-estimate dayrate, Noble Corp is expected to be very profitable over the next two years. In fact, one analyst sees the company earning $3.06 this year and $2.98 next year, which isn't that far off from previous estimates of $3.16 and $3.27. Moreover, it's plenty to cover the company's $0.38 per share quarterly dividend. Further, offshore drilling companies now have a new option at their disposal to keep the dividend afloat.
Master limited partnerships to the rescue?
Offshore drilling companies Transocean and Seadrill both now have affiliate MLPs that can be a source of capital to the parent company. The capital from MLPs, which will come from dropping down older rigs, can be used to fund new drilling vessels, stock buybacks, or even for dividend increases.
For example, analysts at Morgan Stanley recently reiterated their Equal-Weight rating on Transocean despite the current storm in the offshore drilling market. The analysts specifically noted that "Transocean Partners (NYSE: RIGP) increases Transocean's financial flexibility to fulfil its commitment to return capital to shareholders." Further, it "now has the ability to tap on Transocean Partners as an additional source of funding at a lower cost of capital. We believe that accelerated dropdowns could unlock shareholder value for Transocean via dividend support." Because of this, the analysts suggested Transocean Partners give Transocean the ability to sustain its current dividend.
Likewise, Seadrill's MLP, Seadrill Partners (NYSE:SDLP), is being used as a source of capital as well as to secure its dividend. The company pointed this out in the first quarter by noting in its earnings release that the company's board has, "decided to create an additional dividend capacity fund by preserving approximately 20% of any net proceeds from MLP dropdowns." While the intention of this fund is for dividend increases or stock buybacks, it could also prove to be a safety net in the future. This is why the company noted this past quarter that the board sees its current dividend level sustainable through at least 2015, and it's becoming increasingly confident that the dividend's safety can extend well into 2016 even without any significant recovery in the offshore drilling market. Part of this security is because it can use Seadrill Partners as a source of capital to keep the dividend afloat.
The stability that MLPs are providing these two offshore drilling companies is a reason why activist investors are now pressuring Noble Corp to form its own MLP. The company had considered forming an MLP before activists got involved, but that added pressure as well as the continuing pressure on dayrates could cause the company to join its peers.
While worries remain for investors, the offshore drilling market does have some levers to pull to keep dividends afloat. The emergence of new MLPs couldn't have come at a better time, as these vessels should provide the capital offshore drilling companies need to maneuver the current tough market conditions. That's why it appears, at least for the next few years, that investors don't need to worry about their dividends being cut.
Matt DiLallo owns shares of 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.