Going Under the Sea for Profits

By Matthew DiLallo - April 1, 2012 | Tickers: BP, DO, IEZ, SDRL, XOP, RIG | 0 Comments

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While I am a big believer in natural gas and think it has a bright future here in America, it will take years to make the switch to natural gas as a transportation fuel, if that ever happens.  No matter what, I don’t foresee a future without oil in my lifetime.  As we’ve used up more and more of the easy to access oil, the industry needs to continue to dig deeper to supply the world’s insatiable demand. Few companies can go deeper than SeaDrill (NYSE: SDRL) to get the oil that lies deep under the sea.

The Operations

SeaDrill is a contract driller for the offshore oil and gas industry.  What sets SeaDrill apart from market leader Transocean (NYSE: RIG) is how young their fleet is and in this industry younger is better thanks to less maintenance and downtime. SeaDrill has a soon to be 62-rig fleet made up of 21 drill ships and semi-submersibles, 21 jack-up rigs and 20 tender rigs, though 14 of these units are still under construction and due to be delivered by 2015.  While SeaDrill has well less than half of Transocean’s 138 rigs, it’s these 14 new builds that give SeaDrill a lot of visible future growth. It’s a very good time to be bringing new rigs to the market as contract day rates have risen to over $500,000 per day in many of their markets. These rates are giving them very attractive investment economics as they can generate enough cash flow to pay off the rigs in as little as five years.

The Dividend

Instead of paying off the debt used to secure these rigs, SeaDrill uses much of the cash generated to pay a very generous dividend.  At its current quarterly run rate of $0.80 a share, SeaDrill is yielding over 8.5% which is eye openings to say the least. When looking at their competitors, Transocean’s yield was recently just under 6% but that is off the table for at least the next year as it will be suspended as they work to reinforce their balance sheet in light of post-Macondo operational challenges. Given the risks to deep-water drilling that were evidenced in that Transocean operated BP (NYSE: BP) well, it becomes apparent that current valuation of SeaDrill has remained depressed making that yield all the more appealing. When looking at others in the industry a low base dividend is commonly supplemented by a one-time special dividend. Diamond Offshore (NYSE: DO), recently paid out a $0.75 one-time dividend which was a nice boost over their $0.125 quarterly payout.  SeaDrill’s high and growing quarterly dividend really stands out when looking at their peers, but can it last?

The Debt

There is no two ways about it; SeaDrill has taken on a very large debt load to help them build out their fleet. Currently they have $10.4 billion of debt for this $17.2 billion dollar market cap company. SeaDrill however, produces a lot of cash with current EBITDA over $2.4 billion annualized which more than covers their $1.5 billion in annual dividends as well as their interest payments of around $75 million per quarter thanks to their favorable average interest rate of just 2.6%. As I mentioned previously, they have about 14 vessels currently under construction.  As these vessels go into service SeaDrill will start earning income. They estimate that their EBITDA will grow about 10% annually and be just under four billion by 2016. This will deliver even more cash flow to shareholders as well as give them additional flexibility when it comes to their debt profile. 

I like SeaDrill and its gusher of a dividend a lot but at its recent price of $37.50 a share it’s been fairly volatile over the past year with a Eurozone induced panic low of $24.68 last fall and a more recent high of over $42 a share. I think we might be able to get this one a bit cheaper with patience. When I want to try to get a better price on shares of a company I will sometimes turn to a written put.  In the case of SeaDrill I’d be interested in writing the July $35 puts recently around $1.45 a share.  This would net a 4% return on cash used to secure the put if it expires.  If the put is exercised you’ll pick up shares for a combined 10% discount to its current trading price and a forward dividend yield of over 9.5% which would be a good starting price. I think SeaDrill is a very good company to add some oil exposure to your portfolio, I think the divided is safe and will grow safer over time and if we can get it a bit cheaper writing puts that's even better.

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