Seadrill: Is This 10%-Yielder A Good Investment?

| About: Seadrill Limited (SDRL)


Seadrill shares have declined in 2014, but the company's recent results were strong.

Seadrill's operations should improve going forward due to its focus on key strategic areas.

Seadrill's earnings are expected to grow rapidly in the next five years, and this should allow it to sustain the dividend.

Offshore drilling services provider Seadrill (NYSE:SDRL) has an eye-catching dividend yield of 10%. However, the stock's performance has not been impressive in 2014. Seadrill's shares are down 7% in 2014. But Seadrill seems to be making solid progress. The company surprised the Street with its first-quarter results, and looks set to get better in the future. Let's take a look at what will drive Seadrill's performance going forward.

Improving gradually

Seadrill's operating results in the first quarter improved due to a full quarter of operations in West Auriga, West Tellus, West Vela, West Castor, and West Telesto. The operational teams of Seadrill are active in these regions and performed excellently in finding creative solutions and reducing downtime for offshore. Going forward, Seadrill is determined to improve its uptime by applying lessons learned across the fleet.

Seadrill expects to take delivery of West Neptune during the second quarter, which will start its operations in the Gulf of Mexico. West Neptune will be locked in a three-year contract beginning October. Seadrill also expects to take delivery of two ultra-deepwater Samsung drillships -- West Jupiter and West Saturn -- plus the semi-submersible Sevan developer for the rest of 2014.

Seadrill is progressing productively from a financing and strategic perspective. It successfully executed multiple transactions during the first quarter to establish North Atlantic Drilling, or NADL, as an independent funded entity. It has also announced a strategic corporation agreement with Rosneft. NADL is expected to sign up to nine rigs and 35 rig-years worth of contract with Rosneft.

Positives across the globe

Seadrill is also progressing well with its Mexican joint venture, and the units have become ready for operation. In fact, two are running dayrates, one has been prepared, and two are on route to Mexico. Seadrill is witnessing positive developments in Brunei and Saudi Arabia, in addition to attractive opportunities in Mexico, West Africa, and Australia.

The strategic focus of Seadrill is on high-specification new assets, strong uptime, full utilization, and a lean cost structure. The company believes that these factors are helping it deliver results and grow the dividend.

The limited fleet of Seadrill provides significant stability in the current market environment. The drilling giant is believed to be well-positioned to take advantage of potentially tightening market conditions in 2016, based on several factors.

First, there are solid inquires for projects that have just been pushed from 2014 into 2015. Customers are focusing on their bidding activity on units that have dual BOPs, increased deck space, and high variable deck load capacity. Also, Seadrill is focused on building a modern high-specification fleet. The jack-up portfolio of Seadrill has 3% of its fleet available in 2014 and 27% in 2015.

Moreover, there's an ever-increasing demand-supply gap, as evidenced by the rising number of open tenders, increasing pressure on dayrates, and rising contract durations worldwide. On the supply side, there's an accelerating number of retiring rigs, with more than 30 rigs leaving the market in the past two years, which is more than what was scrapped in the previous 10 years.

Therefore, while the near-term market outlook may be concerning, Seadrill is highly confident about the long-term prospects of its business. The medium- and long-term capital will be spent on more profitable projects, which are found in deep and ultra-deepwater.

Dividend, fundamentals, and conclusion

Moreover, analysts are also positive regarding Seadrill's prospects. According to Cowen's J.B. Lowe:

We believe SDRL's 1Q14 release has positive implications for the stock. The quarter was noisy due to the deconsolidation of SDLP, but pro forma EBITDA and operating income of $788mm and $574mm beat our estimates of $738mm and $530mm, respectively. Market commentary was negative, but the dividend was boosted by $0.02 to $1.00/quarter, which was unexpected and should be viewed positively.

Moreover, Seadrill might be able to sustain its dividend going forward. Apart from the improvements that are expected in the business, its payout ratio is also quite reasonable, at 34%. In addition, Seadrill has generated $1.93 billion in operating cash flow in the last one year. Also, analysts expect the company's earnings to grow at a terrific annual rate of 18.7% for the next five years. So, Seadrill looks like a good buy, and its weak performance so far this year looks like an opportunity.

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