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Seadrill (NYSE:SDRL) is a high-yielding dividend stock embedded in a sizzling sector. Oil prices increased by 2% Tuesday. The reason appear to be due to the Iranian tension with Israel and the U.S. Seadrill sports an 8.9% dividend yield.

Day rates for the company's rigs are increasing due to the company's modern rig fleet. The caveat is Seadrill's balance sheet contains a significant percentage of debt. As long as the oil prices remain high, Seadrill should provide lucrative dividends. In this article I will address Seadrill's dividend sustainability and reasons to consider acquiring shares. I also advise caution based upon the high debt level.

Business Model

Seadrill is a leading global offshore oil and gas drilling company. It operates a fleet of over 60 rigs in shallow to deep areas. The company is a global leader of deep water rig units. In addition, Seadrill is the biggest owner and operator of self-erecting tender rigs and premium jack-up rigs. Seadrill has used debt to build out a modern drilling fleet.


Seadrill's Competitive Edge

Seadrill's business focus is, as with most companies, to increase revenues and dividends. The offshore drilling units are equipped with experienced and skilled employees. Employees, as witnessed by British Petroleum (NYSE:BP) amazing blunder in the Gulf of Mexico, can cause financial pain to shareholders. Seadrill hires employees and vessels under long duration contracts and at premium day rates. As oil is presently trading at above $100 per barrel, Seadrill has steadily built out its fleet of new, premium offshore rigs from 5 in 2005 to over 60 in 2012. This was done via new build orders and targeted acquisitions of modern assets.

Growth Opportunities

As oil prices stay at high historical levels and energy demand remains strong, the outlook for offshore drilling remains favorable. Major exploration and production companies are increasing their annual capital spending as oil prices warrant. For Seadrill, this means high asset utilization, significant increase in tenders and requests from customers, and higher day rates - all of which translates into a robust profit outlook.

Financials

Seadrill has consistently grown revenue, earnings and dividends over the years. Revenue has increased from $1.1 billion in 2006 to $4 billion in 2010. Net Income has increased from $245 million in 2006 to $1.172 billion in 2010. For the third quarter ended September 30, 2011, Seadrill reported revenue of $1.03 billion (up from $995 million in second quarter of 2011), operating profit of $480 million (up from $430 million in second quarter of 2011) and net income of $58 million.

Seadrill, as of September 30th, 2011, had an orders backlog of $13.5 billion. Seadrill reported total assets of $18.3 billion, debt of $8.879 billion and shareholders' equity (book value) of $6.772 billion. All of Seadrill's operational units received an overall customer assessment of either good or excellent.

Rig Economics

New rigs cost anywhere from $600 million (ultra-deepwater) to $200 million (shallow water), and are rented out at a day rate of $575,000 to $145,000. These rates are increasing as new contracts are signed. Rig operations cost anywhere from $170,000 to $60,000, resulting in sizable daily profits. Seadrill typically recovers its investment in about five to seven years, but can continue operating rigs for another 15 years or more.

Dividends

Seadrill also increased its quarterly dividend to $0.76 per share ($3.04 per year), with management committed to holding future dividends at this level. With shares trading at the $35 level, Seadrill's annual dividend yield works out to 8.9%, rather attractive by any measure and well ahead of many of its competitors (see table below). Management also believes this payout level is sustainable based on visibility into future earnings, debt service levels, ongoing capital expenditures and the overall outlook for the business.

As of January 17, 2012, Seadrill shares traded around $35. The price to earnings multiple is 8.9x. The company has a market capitalization of $16.5 billion. This is 2.4x the company's book value. The enterprise value is $25 billion due to over $8 billion in debt. Seadrill shares have held up better than its competitors over the past year, which further increases its attractiveness as a core dividend paying stock.

Competition

Transocean Ltd (NYSE:RIG) provides global offshore contract drilling services for exploration and production entities. The company offers deepwater, drilling management, and drilling engineering and drilling project management services. Transocean was sued by British Petroleum over the oil leakage in the Gulf of Mexico. Other related lawsuits are outstanding. The company does offer a 7.8% dividend yield.

Diamond Offshore Drilling, Inc. (NYSE:DO) is a leading deepwater drilling contractor. The fleet includes a diverse rig count in semi-submersibles, jack-ups and dynamically positioned drill ships. Loews Corporation (NYSE:L) owns over 50% of Diamond's stock.

Rowan Companies (NYSE:RDC) offers onshore and offshore oil and gas contract drilling services. The company has global operations providing offshore drilling platforms and deep well rigs. The company is expected to earn $3.27 in 2012. This places an attractive valuation on the non dividend paying company.

Ensco plc (NYSE:ESV) provides offshore contract drilling services to the exploration and production industry. The business model is focused upon offshore drilling under contracts with international, government owned, and independent entities. Ensco acquired Pride International in May 2011.

Seadrill is second in the ultra-deepwater category. Transocean has 31 units in the ultra deep water category. In jack up rigs, Seadrill leads the category with 19 units, followed by Rowan (13), and Ensco (12). In tender rigs, Seadrill is far and away the leader with 20 units.

More interestingly, Seadrill operates newer rigs than its competitors. For example, in the ultra-deepwater category, Seadrill's rigs have an average age of 2 years, compared to 7 years for Ensco, 14 for Noble, 15 for Transocean and 22 for Diamond. In a nutshell, Seadrill has the largest modern fleet in the industry.


Action

Seadrill's balance sheet includes a high debt level. In my eyes, this is a major concern. I personally do not like a highly leveraged balance sheet. I recognize day rates are high, long term contracts are in place, and Seadrill owns the latest and greatest rig fleet. Perhaps my fears are unwarranted based upon the current demand for oil. As the above image indicates, the sector is not always rewarding to shareholders.

Seadrill is clearly a leader in its space. It has a versatile fleet of modern rigs, strong operational experience, a diverse customer footprint, and a clear business strategy. Its shares have held up well and it offers an attractive 8.9% dividend yield. Looking ahead, market conditions appear favorable and the company has a record high orders backlog. All of this makes Seadrill a compelling core holding as a dividend stock. Capital appreciation can be obtained if oil stays high and the debt burden is reduced from present levels.

Disclosure: I am long SDRL. I have a vertical put spread position. I am short SDRL Feb 2012 35.000 puts (SDRL120218P00035000) and long SDRL Feb 2012 33.000 puts (SDRL120218P00033000). This is a credit position where I am seeking Seadrill to trade above $35 per share.

Source: Seadrill Offers Enticing 8.9% Dividend Yield