SeaDrill: Analyzing First Quarter Results, Dividend Increase

May.31.11 | About: Seadrill Limited (SDRL)

SeaDrill Ltd. (NYSE:SDRL) reported its first quarter results on Friday, May 27. The overall results were largely in line with expectations and overall continue to make the company look like a good investment.

First, a few highlights from SeaDrill’s first quarter earnings report:

  • SeaDrill had Q1 2011 EBITDA of $573 million.
  • SeaDrill reported Q1 net income of $823 million. This gives the company a trailing EPS for the quarter of $1.84.
  • SeaDrill increased the dividend to $0.70 per share per quarter. The company also declared an additional special dividend of $0.20 per share to be paid in quarterly installments of $0.05 per share each quarter for the next four quarters.
  • SeaDrill ordered a harsh environment drilling rig named West Linus. The company has already signed a five-year contract with ConocoPhillips (NYSE:COP) for this rig. I briefly discussed this rig and included the details of this contract in an earlier article on Seeking Alpha, which you can read here.
  • SeaDrill ordered two new tender rigs and leased them out to Chevron (NYSE:CVX). The rigs will be under a five-year lease with Chevron once delivered.
  • SeaDrill takes delivery of one ultra-deepwater semi-submersible rig and one semi-tender rig.

SeaDrill’s overall results showed little change from the fourth quarter of 2010. Most of the differences were caused by various accounting rules. The company’s first quarter results explain the causes of the numbers.

  • Revenues dropped from $1,169 million in Q4 2010 to $1,110 million in Q1 2011.
  • Operating profit dropped from $479 million in Q4 2010 to $430 million in Q1 2011. The fourth quarter results included a $26 million gain on the sale of the West Larissa jack-up rig. This is a non-recurring gain and is not included in the first quarter results. That accounts for more than half of the decline in operating profit. The remainder is due to small declines in revenues (and thus profits) from the Floaters, Well Services, and Tender Rigs divisions. The decline in the Tender Rigs profit was also due to non-recurring revenues that were booked in the fourth quarter.
  • Operating cash flow in Q1 2011 was $509 million. This represents an increase of approximately $39.6 million from Q4 2010. Q4 2010 operating cash flow was $479.4 million.
  • SeaDrill’s net income and earnings per share show substantial improvements over Q4 2010. Net income in Q1 2011 was $823 million. Net income in Q4 2010 was $268.1 million. Q1 2011 basic EPS was $1.84 compared to $0.61 in Q4 2010. Most of this was due to a gain of $477 million from the Seawell deconsolidation. SeaDrill’s interest expenses on its debt for the quarter also dropped from $109 million in Q4 2010 to $77 million in Q1 2011.

SeaDrill’s net income for the quarter is abnormally high and it is unlikely that the company will be able to repeat those numbers throughout the year. SeaDrill reported a first quarter EPS of $1.84. Annualized, that works out to $7.36 for the full year 2011. The company had an EPS of $2.73 for the full year 2010. It becomes rather obvious that the company cannot be growing at the rate that the numbers seem to show. It makes more sense to look at the company’s cash flow when comparing quarterly results in this case.

SeaDrill had Q1 2011 operating cash flows of $509 million. This is an increase of $39.6 million (8.26%) over the fourth quarter of 2010. While not as impressive as net income growth, this is still a respectable growth rate. It is also much more realistic and repeatable. If SeaDrill maintains the same operating cash flow for the remaining quarters of the year, it would have a full year 2011 OCF of $2,036 million. This represents an increase of 56.5% over the 2010 OCF of $1,300.4 million. If the company does indeed succeed in reaching an OCF of $2,036 million, this would almost certainly result in an additional dividend increase in a later quarter of this year.

SeaDrill is now paying a forward dividend of $3.00 per share (including special dividend). This gives the stock a forward dividend yield of 8.44% at the May 27 closing price of $35.56 per share. At a dividend yield that high, the company does not have to grow very much to outperform. It does look poised to continue its growth trajectory, however.

SeaDrill secured new contracts for $1.2 billion in this quarter. To put that number into perspective, it is more than SeaDrill’s net income in 2010. It is also very close to the company’s operating cash flow from 2010. As I have mentioned in previous articles on SeaDrill, the company is currently having no problems getting new contracts for its rigs. Furthermore, the company is securing day rates on new contracts that are very close to the current outstanding rates. SeaDrill looks like it is well positioned to take advantage of the growth in offshore drilling.

SeaDrill has continued to expand its fleet throughout the first quarter as it has done for the past several quarters. On November 10, 2010, SeaDrill CEO Alf Thorkildsen briefly discussed the company’s growth potential in a press release:

Our commitment to establish SeaDrill as a leading drilling contractor through investing in new high specification offshore drilling units built by quality yards has been well received by our customers and investors. With the most modern drilling fleet in the world and a total contract backlog of $11.5 billion, we have created a solid platform for further growth and a continued high return to our shareholders.

As Mr. Thorkildsen noted, SeaDrill has a revenue backlog of approximately $11 billion. This is roughly equal to 10 quarters of revenues. The company has expanded since then, however. The company ordered three new rigs in the first quarter, which are under contract (two to Chevron and one to ConocoPhillips). During the quarter, the company had 42 offshore rigs in operation and three stacked units. One of these stacked units will be returning to operation in the second quarter which should have a favorable impact on operational cash flow. The company will be selling the West Juno rig in June and expects to realize an $18 million gain on the sale price.

SeaDrill will also retire the T8 tender rig and expects this to have no adverse impact on the income statement for the second quarter. SeaDrill is retiring the T8 rig because of its age; the company specifically states that the modern fleet is a major competitive advantage for the company (and I agree) and this is one of the oldest rigs owned by the company. West Juno was built in 2010, so the disposal of this rig will not contribute much to the modernization.

Simply put, SeaDrill Ltd. Has a very high dividend that on its own is likely to make the company outperform - particularly if the S&P 500 stays relatively flat over the next year. In addition to that, however, SeaDrill also has rather impressive growth characteristics that should enable the company to outperform. The stock continues to look cheap at these levels.

Zack's Investment Research expects full year EPS to be $2.90 in 2011 and $3.23 in 2012. I would not be surprised to see EPS come in a bit higher than Zack’s predicts due to the abnormally large EPS from this quarter. A 2011 EPS of $2.90 gives the company a forward P/E for the current year of 12.26. The $3.23 EPS estimate for 2012 gives the stock a P/E of 11 for 2012. It gives the stock a PEG ratio of 1.08. Assuming that Zack’s is correct, the fair value for the stock is $32.94. It's predicting $0.68 EPS for the current quarter (Q2). I think that it's right; the current quarter will probably not be as high as the first quarter was.

Net income can be a poor way to evaluate this company for the previously mentioned reasons, however. If SeaDrill can maintain the same OCF throughout the year that it did in the first quarter, then the P/OCF ratio is 7.73 ($4.60 of OCF per share). SeaDrill had negative FCF for the first quarter as is typical for this company (for more information, read my article on SeaDrill’s business model). Analysts are expecting earnings growth for the next year of 11.36%.

At the current prices, an investor buying today is getting the 8.44% dividend for free. The stock has been hovering between $32 and $36 for months -- it is near the top of the range now. If you are willing to be patient, an even better entry price may present itself. The stock is certainly not a bad value at its current price, though.

Disclosure: I am long SDRL.