Offshore drilling giant Seadrill Ltd. (NYSE:SDRL) announced its fourth quarter 2014 results on February 25, 2014. If the number of articles that were posted on Seeking Alpha in the days and weeks surrounding the report were any indication then this announcement was very highly anticipated. Fortunately, it did not disappoint. Seadrill reported strong growth in both consolidated revenues and operating profit, driven primarily by the start-up of several new rigs. Perhaps of most importance to many of the investors that follow my analyses of the company, Seadrill hiked its dividend yet again. This represents the continuation of a streak that has now lasted for four consecutive quarters and has kept the company solidly positioned as one of the top dividend payers on the New York Stock Exchange.
As my regular readers know, I like to start off these reports by providing the highlights from the company's quarter as this helps to put the following analysis into context. Here are the highlights from Seadrill's fourth quarter:
- The company reported consolidated revenues of $1,469 million in the fourth quarter. This compares favorably to the $1,280 million that Seadrill reported in the third quarter.
- Seadrill had an operating profit of $568 million in the fourth quarter. This represents an increase over the company's third quarter operating profit of $471 million.
- Seadrill reported a fourth quarter EBITDA of $768 million. In the third quarter, the company had an EBITDA of $663 million so this represents a substantial increase.
- The company reported a net income of $281 million in the fourth quarter. This represents a significant decrease from the previous quarter's $315 million.
- The company's reported net income works out to $0.49 per share, also a decrease from the previous quarter's $0.61 per share.
- Seadrill increased its quarterly dividend to $0.98 per share. This gives the stock an 11.11% yield at its current level.
While these numbers appear to be quite strong (and they are), the quarter-over-quarter decline in net income is likely to be concerning for many of those reading this. However, a look deeper into the numbers reveals that this is nowhere near as concerning as it first appears. For some time now, Seadrill has owned approximately 40% of a struggling oilfield service company called Archer Limited. This investment has resulted in significant unrealized losses for Seadrill over the last few years and 2013 was no exception. On February 21, 2014, Archer announced an impairment charge to goodwill and other long lived assets of $430 million. Accounting rules require that Seadrill also write down a percentage of this in proportion to its ownership stake in Archer. Because of this, Seadrill took a charge of $185 million to its fourth quarter net income. Excluding this writedown, Seadrill had a net income of $466 million. Thus, excluding the charge due to Archer's writedown, Seadrill significantly increased its net income on a quarter-over-quarter basis.
As with all writedowns, this $185 million writedown due to Archer is merely an accounting charge. Seadrill did not actually spend $185 million on anything and no money actually left the company. Thus, the charge reduced Seadrill's taxes but the actual impact on the money that the company brings in or pays out was minimal. We can see evidence of this by looking at Seadrill's cash flows. In the fourth quarter of 2013, Seadrill had total consolidated operating cash flow of $492 million. This is still a decrease from the $533 million that Seadrill had in the third quarter but the decline was not as large as the writedown would lead one to believe.
Seadrill enjoyed some success during the fourth quarter at increasing the cash generated by its jack-up fleet. During the fourth quarter, the company's jack-up rigs had an economic utilization rate of 98%. This is a slight increase from the 97% that the same rigs achieved in the third quarter. This tells us that the company's jack-up rigs spent more days working during the fourth quarter than in the third and less time undergoing maintenance, being moved, being repaired, or engaging in similar activities. As I have discussed in several previous articles, offshore drilling rigs only generate revenue during times in which they are actually performing work for the customer. Therefore, the increase in jack-up utilization means that this part of the fleet earned slightly more money than it did in the third quarter.
Unfortunately, not all of the parts of Seadrill's fleet were so successful. The company's tender rig fleet only achieved 95% utilization in the fourth quarter, a significant decrease from the 98% that the same fleet segment achieved in the third quarter. This had the exact opposite effect that the increased economic utilization among the jack-up rigs had, resulting in these rigs producing less revenue on a quarter-over-quarter basis. Some readers might note that Seadrill itself does not own any tender rigs and they would be correct. Over the last year and a half, Seadrill has divested itself of all of its tender rigs by selling off each rig to either SapuraKencana Petroleum (OTC:SKPBF) or its subsidiary, Seadrill Partners (NYSE:SDLP). However, because Seadrill owns a majority stake in Seadrill Partners, it consolidates the partnership's results into its own. Therefore, the results achieved by the tender rigs owned by Seadrill Partners ultimately affect Seadrill's results due to this consolidation of results. Historically, Seadrill's (and by extension, Seadrill Partners') tender rigs have been very reliable with minimal downtime. Therefore, there is a good chance that the company can increase this economic utilization rate going forward. This would boost the revenues and cash flows that the company derives from these rigs and thus increase these two figures in future quarters.
Seadrill's quarter-over-quarter revenue growth was primarily due to five rigs starting work on their first contracts. These five rigs are the West Tellus, West Auriga, West Vela, West Tucana, and AOD III. The first three are the most significant as all three are ultra-deepwater drillships and so carry much higher dayrates than the latter two rigs, which are both jackups. These rigs, particularly the West Vela, also offer growth prospects going forward. This is because none of these rigs operated for the entire fourth quarter. For example, the West Vela only began operating in November. Thus, the first quarter will represent the first quarter in which the rigs were in operation for the entire quarter. Thus, they will have more days in operation and so collect more dayrate for Seadrill. This will result in more revenue for the company. With that said, the West Auriga started work on its first contract in October. Depending on which day in October it began operations, the rig may only enjoy a few extra days of revenue and dayrate compared to what it enjoyed in the fourth quarter.
The West Tellus offers an interesting case. The rig began operating in November 2013 for Chevron (NYSE:CVX) in China at a dayrate of $610,000. However, in January, the rig is moving to Liberia to conduct operations there for Chevron at a dayrate of $635,000. The rig will earn this higher dayrate until its contract expires in July 2014. Thus, not only will the first quarter be the rig's first full quarter of operation and thus providing a boost to the revenue that Seadrill generates from it but its dayrate will also increase thus resulting in a further boost to revenue.
As mentioned earlier, Seadrill increased its dividend for the fourth quarter in a row, to $0.98 per share per quarter or $3.92 per share annually. It is unlikely that this dividend will be increased further for the time being, however. The company stated in its earnings announcement that the Board of Directors sees limited value in increasing the dividend any further, despite the company's strong future growth prospects and growing revenue backlog. Therefore, it will, going forward, redirect any funds that would otherwise be used to grow the dividend into a fund that will be used either to finance a dividend hike at some point in the future or a possible future share buyback. Management also suggested that shareholders may see some stock dividends in lieu of increasing the cash dividend. Personally, I think that this is a very good idea. At its current yield, Seadrill is already likely to deliver a respectable return to shareholders even if its stock price stays range bound for an extended period of time. Meanwhile, by postponing future dividend increases, Seadrill can strengthen its debt-laden balance sheet.
Seadrill is already making some moves to strengthen its balance sheet. As a part of its earnings report, the company announced that it is creating an "additional dividend capacity fund" into which it will deposit 20% of any proceeds from future rig sales to Seadrill Partners. This 20% will be paid out to investors in the form of cash dividends (presumably "special dividends") over a twelve month period. The remaining 80% of any money that the company realizes from these sales will be used to pay down debt or finance future growth so that the company does not have to take on more debt. Either of these options will strengthen the company's balance sheet and will hopefully provide some measure of comfort to investors.
Disclosure: I am long SDRL. 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.
Additional disclosure: I am short call options on SDRL.