Seadrill: Short-Term Troubles, Long-Term Growth

| About: Seadrill Limited (SDRL)

On Tuesday, investors did not exactly cheer for the earnings report of Seadrill (NYSE:SDRL) even though the results were not that bad at all. As the company was able to grow its quarterly EBITDA by 16% sequentially and 27% year-to-year, it made several additions to its fleet (West Telus, West Africa, West Vela, West Tucana and AOD III) and received 13 new rigs while posting uptime of 94%.

Seadrill's newest rig addition, West Linus, is already contracted to ConocoPhillips to serve in North Sea for the next five years. The company's next rig delivery will be West Titania (also known as Prospector 3), and this rig will be contracted to Pemex for the next 6 years in order to work in Mexico. In the coming quarters, Seadrill is expected to receive several more rigs, including West Jupiter, West Saturn, West Neptune and the Semi Sevan developer.

The company was able to bump up its dividend per share from $0.95 to $0.98 in order to share its growth with the investors. Seadrill announced that its operational improvements as well as the strong backlog (now at $20.2 billion) provided it with the confidence to raise the dividend. Currently, the company's forward dividend yield is above 10%, and many dividend investors will be initiating or increasing their position in the company.

During the conference call, it was confirmed that the company is committed to return value to investors by maintaining its dividend rate high. In fact, it was also mentioned that the dividend payments would not be cut anytime soon and the next couple years should show flat to some growth, depending on how the company is able to grow its backlog as well as the market conditions at the time of decision. Since Seadrill's management is rather conservative, the company wants to maintain a large backlog as an insurance policy before increasing its dividends any further. In the next couple years, Seadrill's backlog size is not expected to change much, as the company will be fulfilling the older orders at roughly the same rate that it receives new orders. Moving forward, Seadrill will be saving up 20% of the net proceeds it receives from MLP drop-downs for future dividends. Of course, this extra money can come either in the shape of extra dividend payments or increase of existing dividend payments.

Seadrill is currently experiencing some operational difficulties, as the West Alpha and West Phoenix have been struggling with the harsh winter conditions in the North Sea, some equipment dysfunctions were reported in West Pegasus and West Capricorn, and some damage occurred in Canada, which required maintenance work. The company expects all these issues to be fixed or resolved before the end of the month, and it does not expect these challenges to hurt its first quarter results dramatically.

In the short term, drilling activity might be slowing down as large oil companies are looking for ways to cut costs and lower their capital expenditures. On the other hand, oil prices seem to have stabilized and the global energy demand continues to climb, which should help with Seadrill's long-term prospects. In fact, this is exactly what the company is seeing. As reported during the conference call, Seadrill is receiving more inquiries regarding 2015 and beyond, even though some activity might be slowing for the current year. One example is ultra-deepwater drilling activity, which is expected to rise from 1 million barrels to 5 million barrels of daily production between now and 2020. This presents a tremendous opportunity for the company's growth as we move forward. In 2014, Seadrill is looking at an impressive contract coverage rate of 98%, followed by a contract coverage rate of 72% in 2015 (and there is still plenty of time until 2015, which means that the rate of 2015 might be closer to what we are seeing in 2014 as the year progresses).

Because the oil prices have stabilized, the company can look at the spending trends of the major oil companies and determine whether the spending cuts are a result of a cyclical activity or a temporary trend. In fact, Seadrill's management believes that we are not looking at a cyclical activity because it is not coupled with a price drop of oil. The oil companies are still highly profitable and oil price is still near historically high values, which tells us that sooner or later, oil companies will go back to spending mode.

Looking at the company's balance sheet, the total assets remained rather flat as an increase of cash was offset by a decrease of other liquid assets. Despite some debt payments made during the quarter, Seadrill's long-term debt rose from $10.0 billion to $11.9 billion and the company's total debt rose from $12.6 billion to $13.9 billion. In the near future, as oil companies spend less money, Seadrill will be focusing on fixing its current fleet and paying off debt, rather than increasing the size of its fleet. This will be the theme for the next year or two.

The main theme for Seadrill's earnings report was that the company enjoys a large backlog, it continues to grow its fleet size while paying off debt and growing its dividend payments, and the company expects some short-term slowdown followed by long-term growth.

As a result of the earnings report, Seadrill's share price fell by nearly 7%. Currently, the company trades for 3 times its annual revenues, 8 times operating profits and roughly 6 times net profit, with a dividend yield of nearly 11%. In the coming weeks, many dividend hunters may attempt to take advantage of the company's cheap valuation.

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.