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Offshore rig owner SeaDrill (NYSE:SDRL) reported far better than expected second quarter results Monday morning. Revenue accelerated 12.8% year-over-year to $1.1 billion, roughly in-line with expectations. Earnings tumbled 15.5% year-over-year to $1.09 per share, but the year-over-year decline was muddied by a gain on marketable securities in last year's period. Still, the firm's reported earnings amounted to a better-than-expected decline. More telling of its performance during the quarter, operating profit increased 12.3% as the company was able to drive the incremental revenue to the bottom line. Nevertheless, shares are fairly valued at this time, in our view.

Importantly, management acknowledged it had secured contracts and commitments of $7.6 billion since the first quarter, bringing its total backlog to $20.3 billion. The company indicated that the average contract duration is 38 months for its deepwater fleet, 18 months for its jack-ups (was 17), and 29 months for its tender rigs (was 25)-providing improved visibility. Based on this strength and future potential revenue, management increased its quarterly dividend to $0.84 per quarter (was $0.82). The increase gives the company an annual yield in excess of 8% based on its current share price. SeaDrill revised its existing credit facility, increasing liquidity by nearly $600 million, but its balance sheet remains highly leveraged.

Though shares score a 6 on our Valuentum Buying Index (our stock-selection methodology) and trade at the low-end of our fair value range, we aren't fans of the rig owner at current levels. In addition to shares trading in our fair value range, we are concerned about the long-term health of the company's dividend. Management noted strong operating performance, a record high order backlog, and a positive outlook for the drilling industry as reasons for dividend sustainability, but SeaDrill posts a Valuentum Dividend Cushion™ score of 0-suggesting the dividend is at significant risk going forward. Either management will have to make sweeping changes to the growth and profitability of the firm or access the equity/debt markets to sustain the dividend, which may have dilutive implications on shareholders. Our Valuentum Dividend has had tremendous success in predicting dividend cuts, with JC Penney (NYSE:JCP) and SuperValu (NYSE:SVU) being two recent examples.

Though the high-single-digit annual yield is tempting, the company's poor dividend safety and modest growth potential--it only raised its dividend 2%--will keep us from adding shares to our actively-managed portfolios anytime soon.

Source: We Don't Think SeaDrill's Dividend Is Sustainable