Income investors have long loved
for its 11% yield and fast-growing dividend. The company's rapid
fleet expansion has seen the company grow quickly and, combined
with the dividend, has rewarded long-term investors with
However, in the past few quarters, the offshore drilling
industry has faced declining demand, as major oil companies pull
back on spending. In addition, new rig supply has resulted in
what Seadrill's management calls "fierce" competition for new
ultra deep-water (UDW) rig contracts that resulted in the
growth-happy company announcing it would no longer be ordering
new rigs until market conditions improved. The announcement
was made during the release of Seadrill's second-quarter
earnings, which plunged 63% from a year ago.
What about the dividend?
For the quarter, Seadrill maintained its dividend at $1/share,
and reiterated its commitment to this payout through
2016. However, with the current dividend costing the company
$469 million/quarter, investors can be forgiven for worrying
about the long-term sustainability of the dividend. This is
especially true given the fact that in the past six months,
Seadrill has paid out $938 million in dividends, yet cash flows
from operations have only been $881 million. During this time,
Seadrill spent $2.165 billion on expansion and debt
As I'll now explain, there are several reasons to be
cautiously optimistic that Seadrill's dividend is safe, and that
the company's long-term prospects remain bright.
The bright side of earnings
Source: Seadrill Q2 Earnings Presentation, page 4.
As seen above, Seadrill's EBITDA, or earnings before interest,
taxes, depreciation, and amortization, rose 30% and achieved a
record high. Similarly its UDW fleet utilization remained high at
94%, and CEO Per Wullf stated that he expects this to increase to
98% for the third quarter.
This high utilization is evidence that, though demand has
softened, Seadrill's fleet of young, state-of-the-art ships
remain in high demand through at least 2016, when analysts
believe the market will improve, and can still command premium
day rates. This puts Seadrill in a much better situation than
competitors such as
Diamond Offshore Drilling
, whose fleets are far older and face daunting contract cliffs in
the years ahead.
Source: Seadrill Q2 Earnings Presentation, page 9.
The fact that Seadrill was able to secure new contracts for
its West Saturn and West Jupiter UDW rigs at rates of $633,750
and $567,000 respectively, illustrates that the company's
superior fleet has thus far been largely immune to the market
With a total contract backlog of $20 billion, Seadrill's
dividend is in no immediate danger. As long as the company can
continue securing similar rates for its 14 uncontracted new
builds, management's confidence in the sustainability of the
company's payout will prove correct.
Alternative financing further secures payout
Source: Seadrill Q2 Earnings Presentation, page 18.
During the second quarter, Seadrill sold 230 million shares of
SapuraKencana for $300 million. As the above image shows,
the company still has $1.21 billion in investments that it could
tap should market conditions get worse.
In addition, Seadrill was able to raise $373 million from its
MLP, Seadrill Partners, by selling it a 28% stake of Seadrill
Seadrill's other MLP, North Atlantic Drilling, of which
Seadrill owns 70%, just won a $4.1 billion contract to provide
five harsh environment rigs to Russian oil giant Rosneft starting
in 2015. Growing distibutions and incentive distribution fees
from its MLPs should help Seadrill secure its dividend during
this period of temporary weakness.
Seadrill was also able to secure $2.85 billion in credit to
refinance three rigs and finish building three others. This
shows that the credit markets are still willing to offer the
company ample and attractively priced debt to complete its
aggressive growth expansion, while continuing to fund the
Risks to watch for
According to Per Wullf, the fact that oil has remained at
$100/barrel for the last 3.5 years has been integral to his
company's success. Oil's high price has been supported by
the global economic recovery increasing demand, especially in
nations such as China and India. A global recession could see
plunge, which would turn the short-term weakness in the offshore
market into a potentially much longer cyclical downturn. For
Seadrill, a company with $12.2 billion in debt, such a situation
would certainly put the dividend at risk.
Investors should watch for management to continue securing the
balance sheet -- Seadrill's long-term debt decreased 7% this past
quarter -- and watch to make sure the company can secure
good day rates for its large number of upcoming new builds. This
is especially true beginning in 2015, when Seadrill's management
believes the market will begin to strengthen.
The downturn in the offshore drilling market is expected to last
another year or two. In the meantime, older rig operators are
likely to face brutal downward pricing pressure, shorter
contracts, and diminished cash flows. Thus far, Seadrill has
largely avoided these problems, and its dividend remains secure.
Patient long-term income investors who are willing to buy on the
current weakness are likely to be rewarded with both a generous
yield, and long-term market beating total returns.
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Seadrill Earnings: Is the Dividend Still
originally appeared on Fool.com.
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