Seadrill: Hope For The Future

| About: Seadrill Limited (SDRL)

If your primary investment objective is earning income on dividends, then Seadrill Ltd. (NYSE:SDRL) is your type of stock.

In 2009, the Norwegian offshore drilling contractor paid a quarterly dividend of 50 cents per share. Its most recent payout was 85 cents a quarter and $3.40 per share on an annual basis. The dividend yield is a healthy 9%, and earnings growth for the company would likely increase the dividend even more.

How long it can continue paying out a robust dividend remains to be seen.

Increased Debt, Stagnant Stock Price

Shares of Seadrill have moved very little in the last year, with a 52-week trading range of $31 to $41 a share. It currently trades around $37, giving it a fairly modest price to earnings ratio of 17.65.

Certain factors indicate difficulty in maintaining such a generous dividend payout. First is the company's inflated payout ratio of 160%, which means it is currently giving back to shareholders $1.60 for every $1 in earnings. Second is Seadrill's debt-to-equity position, currently a ratio of 1.52. That means for every $1 in equity the company has, it's saddled with $1.52 in debt. If the company's debt climbs further, it may be difficult to reward investors.

Seadrill's growing debt is one reason the stock was downgraded by TheStreet Ratings in early March. It has a quick ratio of 0.57, meaning it can only pay off 57% of its current liabilities with its current liquid assets. Also troublesome is the 43% decline in net operating cash flow from the fourth quarter of 2011 to the fourth quarter of 2012.

The company's total cash balance at the end of last year was $318 million, down from $483 million from the year before and $755 million from the end of 2010. In the capital intensive industry of oil drilling, cash is a necessary asset. Meanwhile its liabilities grew from $2.9 billion at the end of 2011 to $3.6 billion at the conclusion of last year.

Hope For The Future

Yet, there's hope the company can turn those numbers around. During its earnings release, Seadrill announced that it had added contracts worth a potential $2.3 billion in just the fourth quarter. At the end of February of this year, its contract backlog had revenue potential of $21 billion.

"The offshore drilling industry continues to benefit from strong spending of oil and gas companies worldwide which support the growth in the current newbuild programs," said the company in its earnings report. "Exploration success in frontier locations such off east Africa such as Tanzania and Kenya and in more developed areas like West Africa, U.S., Gulf of Mexico and the North Sea provide future opportunities..."

Seadrill reported quarterly revenue of $1.22 billion, 8.3% higher than the prior-year quarter's $1.04 billion. Earnings per share came in at $0.49, far less than the $0.57 a share analysts anticipated. Since reporting a $128 million loss during the fourth quarter of 2011, the company has reported decent earnings for the past year, with earnings per share between $0.65 and $0.75 during the first two quarters of 2012.

One of the key indicators of efficiency in the drilling business is utilization rate, which is a percentage of how much of the company's drilling assets are being used in a particular period. The company's management has stated a goal of 95% utilization. Until most recent quarters, Seadrill achieved rates in excess of 90%. However, rates have been hovering in the low to mid 80s over the last several quarters due to downtime caused by equipment breakdowns. The trend won't be reversed in the early part of 2013, as the company reported that it had already experienced the equivalent of 117 days of downtime due to mechanical issues. Getting those rates back up, however, will increase revenue while decreasing costs in repair and downtime.

The downtime troubles seem to have had little to no impact on margins. For the previous quarter, Seadrill reported a gross margin of 60.2%. Its gross margin for all of 2011 was 58%

Analyst Sentiment Mostly Positive

Analyst sentiment is mostly positive. Analysts are estimating earnings per share of $0.60 with revenue of $1.15 billion for the first quarter of 2013. For the year, analysts are projecting earnings per share of $2.99 with revenue of $4.97 billion, which is 10.90% higher than 2012.

The stock has a five-star rating (out of five) at Motley Fool CAPS, with 999 members out of 1,007 rating the stock outperform, and eight members rating it underperform. Of Wall Street recommendations tracked by S&P Capital IQ, the average opinion on Seadrill is hold, with an average price target of $42.65.

The company was also upgraded by research analysts at HSBC from a "neutral" rating to an "overweight" rating with a target price of $44.75 on March 5, 2013. Analysts currently have a mean target price of $43.23 and a median target price of $46.00 for the company.

New Operations Coming Online Soon

There does seem to be a method to the company's madness as it relates its debt, one aimed at long-term growth. The increased debt load is financing many projects

Seadrill expects to increase its operating fleet by a minimum of 10 units in 2013, with four additional units each year in 2014 and 2015. The company said it expects a "material increase" in cash flow during the fourth quarter of 2013 when 11 new units will be in operation compared to fourth quarter 2012.

The risk to the company and its investors is that the debt the company bears hinges on continued demand for oil and drilling rigs. If the price of oil drops and exploration activity goes down with it, Seadrill may not recoup the return on its investment. If that occurs, paying a dividend may be the least of its worries.

Additional Disclosure: Catalyst Investments is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. This information is not investment advice or a recommendation or solicitation to buy or sell any securities. Catalyst Investments does not purport to tell or suggest which investment securities readers should buy or sell. Readers should conduct their own research and due diligence and obtain professional advice before making investment decision. Catalyst Investments or anyone associated with Catalyst Investments will not be liable for any loss or damage caused by information obtained in our materials. Readers are solely responsible for their own investment decisions. Investing involves risk, including the loss of principal.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.

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