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Seadrill (NYSE:SDRL) is an offshore drilling company with an industry leading position in deepwater drilling. Seadrill shares have returned 12% over the last year which is fairly mediocre given the rise of the S&P and other major stock indices. However, shares are up a whopping 569% since 2009 and investors get a very attractive dividend from Seadrill.

With a 12% return over the last year Seadrill is definitely not the worst performing company in the sector. Diamond Offshore Drilling (NYSE:DO) for instance has corrected quite substantially since February 2013: DO shares lost 22% since February and 11% over the course of a full year. Ensco (NYSE:ESV) just managed in November to crawl back into positive territory with a full year gain of 5%. Noble Corporation (NYSE:NE) gained 11% and industry heavyweight Transocean (NYSE:RIG) 12%. Apart from Seadrill, Transocean, one of the largest US offshore drillers in the sector, is also a very attractive investment opportunity for investors who want to purchase an industry leader in ultra-deepwater drilling at a discounted price. Helmerich & Payne (NYSE:HP) has made investors 53% richer over the last year and the company is by far the best-performing contract driller in the peer group.

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Industry background

Seadrill and other offshore drillers benefit as the oil and gas industry already has 'picked the low hanging fruit' over the last decades. Offshore oil and gas reservoirs are harder to reach and more technological and engineering skill is required to gain access to those reserves. It is no secret that energy demand for manufacturing, transportation and heating is going to go up as the world population grows and richer Asian economies increase their energy per capita consumption. Not only do emerging countries exhibit higher population growth than Western countries, but residents of emerging countries want to increase their life standard by achieving mobility and buying products that cover more than basic needs. Consequently, energy demand will mainly be driven by emerging countries in the future while at the same time access to deep oil and gas resources is limited and it becomes harder to find and utilize new discoveries. Those factors benefit offshore drillers like Seadrill and Transocean; two companies with extensive deepwater drilling experience.

Distribution history

The main reason I have purchased Seadrill for my income portfolio, however, does not relate to the supportive secular and cyclical energy trends that are developing, but because of Seadrill's income distribution to shareholders. Seadrill currently pays $0.95 per quarter in dividends which translates to a forward dividend yield of 8.87%. Seadrill has increased or at least held steady its quarterly payout to shareholders eleven times since Q4 2010. In the last twelve quarters Seadrill paid a special dividend twice which supplemented the already decent quarterly dividend.

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Low earnings multiple & high dividend yield

Seadrill trades at 11.66 forward earnings which is just a slight premium to the offshore drilling peer group average of 10.24. Transocean, Seadrill's closest competitor in terms of ultra-deepwater units, trades at 8.96x forward earnings. Transocean, Ensco and Noble Corporation also appear to be undervalued compared to their earnings potential.

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As mentioned above, the prime reason for adding Seadrill to an income portfolio is its outstanding yield of 8.87%. In fact, Seadrill offers investors diversification into the exploration/energy business and could be considered an alternative to high-yield MLP income plays such as Kinder Morgan Energy Partners (NYSE:KMP) or Atlas Pipeline Partners (NYSE:APL).

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Seadrill trades at a 14% discount to the peer group average P/E of 10.24. The premium isn't at all significant as the peer group itself seems to be lowly valued and as Seadrill's dividend yield ranks substantially above the peer group average dividend yield of 4.90%.

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Conclusion

Seadrill might be an interesting addition to portfolios to accentuate dividend streams. Now, Seadrill's dividend might not be as stable as the dividend from other companies, but investors do not take too large a risk when they purchase Seadrill at less than twelve times forward earnings. Current share prices reflect an earnings yield of 8.6% and a dividend yield approaching 9%. It is also likely that dividends will be increased in the future if capex expenditures and EBITDA growth support such payments. Management has demonstrated its commitment to put shareholders first and pay substantial amounts of cash in form of dividends (~$1.8 billion per annum). Given the low valuation level of Seadrill, its high dividend yield, strong projected EBITDA growth and favorable long-term economics, I rate Seadrill a long-term Buy for income oriented investors.

Source: Seadrill: Why You Should Buy This Distribution Champ For Your Income Portfolio