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As oil prices continue to slide due to the uncertainty in the global economy majority of the oil space has been punished and taken down in value with the price of crude over the last 30 days. When these types of situations happen I like to take a deeper look within the sector to see if there is anything of real interest and value that I can get at a cheaper price.

After looking through the oil and gas drilling sector there are a lot of very good companies that I won't mind owning. Some of the stocks specific to the drilling sector that have been beaten down in value in the past 30 days include Ensco plc. (NYSE:ESV), Noble Corp. (NYSE:NE), Transocean Ltd. (NYSE:RIG), National Oilwell Varco, Inc. (NYSE:NOV), Halliburton Company (NYSE:HAL), and Seadrill (NYSE:SDRL).

When trying to determine which driller is the best fit there are a number of things that I normally take into consideration from both an economic standpoint as well as a financial aspect. After examining the stocks listed above the one stock that really stood out to me was Seadrill.

Seadrill's primary business is the leasing of offshore drilling equipment and services to the oil and gas industry worldwide. Seadrill enters into contract(s) with bigger oil and gas companies like Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), ConocoPhillips (NYSE:COP), Royal Dutch Shell (NYSE:RDS.A), and BP pc (NYSE:BP) for the rights to use their rigs for a predetermined time frame. Depending on the size and type of rig Seadrill can charge anywhere from $649,000 - $127,000 per day for the use of their rigs.

According to Seadrill's most recent Q1 filling Seadrill has been quickly selling out majority of their excess rig capacity for 2012 and is now pushing new contract leasing availability out until 2013. Seadrill currently has a $9.2 Billion floater rig contract backlog. These types of high demand limited supply economic scenarios are what I like to see when considering whether or not to begin building a position in a company. Seadrill is also working on the building/development of additional rigs to add to their fleet that would add a potential of another $1.9 million to their daily rate portfolio.

As crude oil continues to experience a roughly 21% decline in the past month it makes sense that the market has been getting a bit skittish on these types of stocks. Rather than simply running away from the sector, where I think there might be opportunity, I think that there are a few questions that need to be answered first. The first question that I think needs asking is, how much longer does crude oil continue to sell off before it either rebounds or stabilizes? The second question would be, does Seadrill have enough contracts already locked up to weather this potential slowdown contagion storm?

To answer the first question, I think the future of the price of oil can vary a lot from investor to investor based on how fast and far they feel this European contagion can spread and for how long. Personally, I feel confident that Europe will find a beneficial solution to their problems, which will stabilize the global markets, even though it might not be on the same time horizon that the U.S. or Wall Street would like. From a pure economic standpoint world oil demand rose 8.3% this year compared to last and as populations and world economies grow/develop that demand will only continue to push oil prices higher.

To answer the second question, after looking at both Seadrill's potential pipeline and their current contract mix, I feel confident that they have enough currently locked up in the next 12-36 months to weather this crude oil sell off and possible European contagion threat. The danger with a stock like this is that crude continues to sell off and does not come back or stabilize at a reasonable price and all of the contracts that Seadrill does currently have are not renewed once they come due. To help better visualize where Seadrill stands from a contracting standpoint, below is a breakout of Seadrill's current contracting according to their most recent Q1 report.

Contracted Daily Rate

<12 Months

12 - 24 Months

24 - 36 Months

36+ Months

$125,000 - $250,000

6

6

7

8

$250,000 - $400,000

0

0

0

3

$400,000 - $600,000

1

1

2

5

$600,000+

1

1

0

2

** This chart does not include the 12-18 new contracts/builds that are currently underway

I don't like to assume that anything is ever too good to be true and with Seadrill it definitely is not. Seadrill compared to their competitors is a relatively new company that finances majority of their new rig purchases through debt. Seadrill currently has $9.1 Billion in long term debt on their balance sheet. Their current cash on hand is $600 Million, while their overall operating income (profit) for the most recent quarter was $456 Million. Seadrill this past quarter did post a net income of $416 Million ($0.89 EPS), which was an increase of $479 Million compared to the prior quarter's net income of $-63 Million ($-0.23 EPS). Still Seadrill's current debt load is of concern especially with a total debt-to-equity ratio of 1.75, which is a bit high.

An area where Seadrill does stand out from their peers is with their current dividend yield and overall shareholder distributions. Seadrill currently has a dividend payout of $.82/share (excluding the extraordinary dividend this quarter of $0.15/share, which puts this quarters payout at $0.97/share), which at current pricing gives the company a yield of about 10%. This yield is significantly higher than that of Seadrill's peers and the industry average of 3.5%. Again, I realize that a higher yield can mean a lot of things and is not always indicative of a strong company and brings up the question as to whether the company will or can continue to have the ability to pay the dividend.

After looking at Seadrill's most recent Q1report, reading through their guidance through the remainder of this year and into next year, and looking at the current contracted work that Seadrill is getting paid for as well as the new rigs that will be added to their portfolio I am feeling confident that they will be able to continue to pay their current dividend rate, while still managing their debt load. Seadrill currently maintains a profit margin of 41.81%, an operating margin of 43.43%, and average return on equity of 27.63%. As Seadrill continues to expand its portfolio and with its current contracted performing portfolio, the company is expecting to grow their EBITDA to around $4 Billion from their current $2.4 Billion, which also helps reinforce their ability to continue paying such an above average dividend in the sector.

Now, for those that are frequent readers of my articles they will know that I never like to just go all in on a stock at its current price. Instead, I like to look at the options market to help me slowly accumulate a position over time while taking advantage of the heightened volatility within the sector. My interest in Seadrill is no different and is a stock where I would strongly suggest selling some cash covered puts to begin establishing position.

Selling puts basically obligates you to purchase the stock at that price for the equivalent number of put option contracts that were sold (1 contract = 100 shares of stock). At expiration of the option contract if the stock is at or below the option's strike price the seller will be obligated to buy 100 shares of stock for every 1 option contract sold at the option strike price, in other words the seller is being 'put' to the stock. If this happens the seller is still able to keep the premium that was received for selling the puts originally. If the stock price is above your option strike price at expiration the contracts expire worthless and the seller gets to keep the premium that they received originally for selling the puts.

I would suggest selling three different put option contracts at three different strike prices to try and help defer the break even cost if the trader ends up getting 'put' to all three contracts. I like the October contract month because it is roughly 4 months out and provides for a nice time premium as well as having a lot of the recent volatility being built into the price. With that said, I would suggest selling the 30.85 strike for $2.20, the 29.85 strike for $2.05, and the 26.85 strike for $1.05.

It is a bit of personal decision in determining what the individual contract weighting should be, for this example I am just going to assume that one contract for each strike price was sold. Doing that would give the trader an average cost basis of $29.18/share, assuming that all contracts expired in the money. If the trader was to factor in the premium collected for doing the trade their 'real' breakeven would be around $27.41/share. Again, this is assuming that all three contracts were to expire in the money. If only one or two of the contracts were to expire in the money and the trader was 'put' to the stock the premium from the contracts that expired worthless would further offset the 'real' cost of owning the stock.

I like this trade as a potential way of entering into a position on Seadrill because it offers me the possibility of a lower entry point than where the stock is currently trading, as well as paying me to wait and see. The premium that is collected for the trade creates a 6.05% rate of return (or discount if 'put' to the stock) for waiting to see how the price movement plays out. In the event that the options expire in the money and I have to buy the stock, I not only get to keep the premium that I received for doing the trade, but I now have a stock that is currently yielding 11.24% at my $29.18 breakeven. Overall, I see this trade as a win-win and I would be a buyer of Seadrill at the $29.18 level.

Source: Drilling Down For Profits With Seadrill