SeaDrill: Leasing to the Big Boys
Location: Ikkyu2's CAPS Blog
Seadrill is a company that kept showing up on my screens, and I thought "huh, sounds like a competitor to Diamond Offshore and Transocean, why have I never heard of them." I kept making a mental note to follow up, never did.
Well earlier this morning I posted/complained here that I found nothing - no, nothing, not a thing, Alfred - that I could bear the idea of being invested in - no, Alfred, not for a moment - and so when awallejr commented on my post, noting that he saw 'a ton' more attractive than cash, my ears perked up.
And when he mentioned SDRL, I thought, hm, that's one coincidence too many. I'm going to take a look here.
They haven't been around very long and they have a funny capital structure. They came public in 2011 and promptly took on huge debt, started building new rigs and leasing them out. As far as I can tell, management is heavily populated by old Norwegian oilmen and young London financiers - winning combination, seems to me - and indeed they've done well, posting stratospheric earnings and dividend growth and maintaining an unheard of 58% gross margin. Debt to equity is about 180% today; debt to assets, probably a better metric for a leasing company, is about 58%. Payout ratio is about 79%; the eye-popping yield is currently 11%.
There is some complexity; they own part of an MLP, Seadrill Limited Partners, to which they are frequently spinning off assets. The MLP yields 6.6%-ish; because of the way MLP dividends are treated, you have to back them out of your IRA with annoying and time-consuming paperwork (important when your accountant gets paid by the hour) with the result being, you might as well hold the MLP shares in your taxable account, where the dividends are very favorably treated indeed due to tax-favorable pass-throughs inherent to the MLP structure. As far as I can tell SDRL also owns and receives minority interest income from two other well drillers, although I haven't deep-dived the financial statements to learn more about that.
The bull and bear cases are not complicated, despite the above. The bull case is that Seadrill's rigs are state of the art, young rigs, optimized for deep and ultradeep drilling and submersible drilling, built with the latest tech, efficient with the least downtime, and can access oil that other players' rigs cannot. Evidence of this is plentiful and boils down to the fact that XOM and other major players seem to be keeping SDRL's rigs fully employed and are paying a premium to market "day-rates" in order to do so. Management also notes that, despite the predicted slowdown in offshore drilling and the predicted oversupply of rigs, that they believe they have all their rigs, including those under construction, allocated through 2014 and much of 2015 already. They have boosted their dividend last quarter, and have repeatedly declared their belief that the dividend is sustainable; but have fairly well indicated they do not expect dividend increases going forward, and have gone so far as to state that they have spun all their growth/risk rig opportunities into the MLP, for which they do expect to grow the dividend going forward.
The bear case is a bunch of analysts pointing at management, thumbing their noses, waggling their fingers, and saying "You're wrong!" And that the supply glut is more than SDRL estimates, the margins commanded by the newer, shinier rigs are less sustainable than SDRL estimates them to be, and that demand for offshore oil is going to reduce more than SDRL management has predicted. (I have no idea of the interfungibility of the oil SDRL extracts with the sour shale sands extracts; maybe someone who knows more can hip me to the latest arguments on this topic.)
Awallejr's criticism - that inflation was eating me alive while I sat at the side - struck right to my very heart. I am all about capital preservation right now. But SDRL management has stated that the dividend is good for a year, and I think I like their rough-riding Nordic take on affairs - I mean, really, do you see your pump prices dropping right now? - may carry the day. In fact, I have invested in this thesis with a large proportion of my cash hoard, hoping to collect the dividend for a while and be able to get out with a modest profit for my exposure without suffering capital loss. I do note that 11% yield suggests the market thinks a large dividend cut is coming, which would likewise reduce the value of capital commensurately; I don't know how much lower the price can go without a dividend cut - what are the naysayers going to do, short these shares through ex-div day? I doubt it.
The stock is trading at 35.50, just above its 52 week low at 32.40, where Cramer was bullish on it; and well off the highs of 48; Cramer advised folks to get out at 42. I think that unless management is really selling a bill of goods - which they may well be - or unless there's a rig fire or, heaven forbid, Deepwater Horizon II - the prospects are good. But I am under no illusions - there's some risk here, and I'm taking the risk because I want to collect this dividend until other investments appear more favorable.