Seadrill - A Very Risky Dividend Play

Jun.20.13 | About: Seadrill Limited (SDRL)

Seadrill Limited (NYSE:SDRL) is a Bermuda-based offshore drilling services firm. The stock is trading near all-time highs with a dividend yield of about 8.8%, probably the highest in the O&G services industry. In FY 2011 and FY 2012, it has paid out more in cash dividends than it generated in operating cash inflow.

This company has not only paid out very high dividends but also invested significantly in the growth of the company. This article attempts to explain how SDRL was able to manage high levels of investments as well as dividends, and whether this dividend is sustainable going forward.

As of April, 2013, Seadrill operates 44 offshore drilling units and has 19 units under construction. Seadrill has secured contracts (on delivery) for only 10 out 19 Newbuildings. According to Note 10 of the latest quarterly report, the "Newbuildings" (assets) have increased from $1.882 billion in 1Q2012 to $2.654 billion 1Q2013. This means that a significant portion of the assets is locked in construction of drilling units as opposed to cash flow generating drilling units. As per the note, no Newbuilds were reclassified to drilling units in the first quarter. This is likely to put a lot of stress on the short-term liquidity of the company. With current assets at the same level on a YoY basis and current liabilities exploding from $3.6 billion to $4.782 billion, the company has very little financial flexibility.

The interest cost has also increased by 52% from $71 million in 1Q2012 to $108 million in 1Q2013 while the Operating Income has only increased by 21%. The Total Net Income attributable to the company (including its subsidiaries) has actually decreased marginally from $416 million to $409 million. With EPS of $0.85 per share, the management probably expects significant cash-flows in coming quarters to support a dividend of $0.88.

The debt maturity schedule is a cause for some serious concern.

Year (all numbers in $ millions) Debt due
2014 2,598
2015 1,896
2016 1,209
2017 1,481
2018 and thereafter 3,382
Effect of amortization of convertible bond -85
Total debt 10,481
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The weighted average maturity of the debt is about 4 years, which may suggest that the lenders are unwilling to hold the debt for longer maturity. With 14% of the non-current assets tied up in "Newbuildings" that are not generating cash and increased current liabilities, the company may have to sell assets to pay interests costs and dividend and to roll over the debt at a higher interest rate.

How did SDRL manage dividends as well as investments in the past and can it use the same strategy?

Year Dividend per share Total Dividend ($ millions)
2009 0.5 199
2010 2.41 990
2011 3.135 1423
2012 4.31 1,900.00
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Seadrill has managed to pay dividends to its shareholders predominantly using debt. It has also used derivatives such as TRS, interest rate swaps, and entered into financial transactions with subsidiaries to keep its dividend. For example, Seadrill provides debt to one of its subsidiary and asks the subsidiary to simultaneously declare dividend. With (say) a 70% ownership in the subsidiary, it is able to claim 70% of the dividends declared. These short-term tactics have worked in favor of Seadrill's shareholders.

But the bigger issue is the consolidated balance sheet and the cash-flows supporting the dividends and investments.

(All figures in $ millions) 1Q 2013 2012 2011 2010 2009 2008
Net Operating Cash Flows 423 1,590 1,669 1,210 1,349 401
Net cash used in investing activities -1,074 -1,360 -2,486 -2,207 -821 -3,847
Operating Cash flow - Net Investments

-651

230 -817 -997 528 -3,446
Financing Cash flow (Excl dividends) 694 1505 1961 2,283 -254 3514.5
Dividends 0 1,900 1423 990 199 688
Net Cash 361 318 483 755 460 376
Total current liabilities 4,782 3613.00 2771.00 2034.10 2,034.10 2,058
Current portion of long term debt 2,598 2066.00 1419.00 980.60 774.1 746
Total current liabilities - Current portion of long term debt 2,184 1547.00 1352.00 1053.50 1260.00 1,312
Total current assets 2,350 2354.00 1967.00 2,883 2261 1,664
Total current assets - cash 1989.00 2036.00 1484.00 2128.00 1801.00 1287.80
Net Current Assets (Non cash) -2793.00 -1577.00 -1287.00 93.90 -233.10 -770.00
Cash/Current portion of long term debt 13.90% 15.39% 34.04% 76.99% 59.42% 50.40%
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As it can be seen from the past 5 years data, Seadrill has managed to find cash for its investments by sacrificing short-term liquidity. Since 2008, the company has secured total financing of about $10 billion. The operating cash flows net capex has been negative for most years. In FY2012, when it was +230 million, an additional debt of $1.6 billion was raised and this cash was used to pay a record $1.9 billion in dividends.

It is very likely that the lenders have consciously made the loans of shorter maturity. The current portion of the long-term debt has increased from $746 million in 2008 to $2.6 billion in 1Q 2013. It now accounts for 25% of the total debt. It is unlikely that this debt will be repaid in full without sale of assets, dilution of equity or selling stakes in subsidiaries. The company's short-term liquidity is also not supported by the fact that the amount of cash on the balance sheet has not increased significantly since 2008, although the current portion of the debt has only increased. The ratio of cash to current portion of long-term debt has fallen from 50% in 2008 to just under 14% in 1Q 2013. This will make the cost of rolling over this debt significantly higher in the coming quarters.

Conclusion: There are only two possibilities for this company. Either the offshore drilling market picks up very quickly and enables Seadrill to get higher operating cash flows to support its dividend. Or Seadrill sells several of its assets and pays dividends to its shareholders.

Otherwise, with rising interest costs, it is unlikely that Seadrill will be able to keep the dividend intact. Perhaps the management is more optimistic than I am.

(Sources: Annual and Quarterly Financial Reports)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.