Seadrill: A 10% High-Yield Alternative To REITs And MLPs

Seadrill (SDRL) is an offshore deepwater drilling company that, I think, still makes a great value proposition for investors seeking high dividends as well as exposure to the drilling industry. The company posts consistently high economic utilization rates and operates one of the largest fleets of drillships, Jack-ups, semi-submersibles and tender rigs.

Over the last year, shares of Seadrill have been effectively flat with a return of minus 0.11%. Year-to-date Seadrill has lost 7.76% and the stock is down 23.14% since its 52-week High of $48.09. Transocean (RIG), another leading offshore drilling company, lost even more with a trailing twelve month return of minus 18.70%. Shares of competitor Diamond Offshore Drilling (DO) literally collapsed during 2013 as worries about the growth of the offshore drilling market started to capture investors: Diamond Offshore Drilling lost 31.77% over the course of last year and had one of the worst performances in the sector. The stock is also down 15.72% year-to-date and 35.37% from its 52-week High of $73.19. Noble (NE) and Ensco (ESV) delivered negative one-year returns of 12.21% and 11.81% respectively. The following graph depicts the one-year performance charts of offshore drilling companies:

(Source: Yahoo Finance)

Background

Despite cutbacks in exploration spending and a cautious growth outlook for the offshore drilling market, I think the long-term fundamentals of the offshore business actually support an investment in Seadrill. Large offshore oil- and gas discoveries have not only become rare, it is also increasingly difficult to exploit newly discovered reservoirs. Exploration companies now need to dig deeper and have to go farther offshore to find new oil- and gas reservoirs that are worth the cost and the effort. Drilling companies like Seadrill will benefit from long-term fossil fuel demand and increased drilling activity to bring new supplies to market.

Seadrill actually has performed quite well over the last three years - its quarterly EBITDA has consistently been above $573 million. Most recently, Seadrill reported the largest sequential increase in EBITDA in three years. Its fourth quarter EBITDA came in at $768 million: A 15.8% increase from the $663 million in EBITDA reported for the third quarter 2013.

(Source: Seadrill Conference Call 4Q 2013 Presentation)

Seadrill's distribution history is quite impressive, too. The offshore driller has just increased its quarterly distribution by $0.03 to $0.98. Since the fourth quarter 2010 Seadrill has held its dividend payment at least steady and has increased its recurring dividend (not accounting for special distributions) ten times during the same time period.

(Source: Seadrill Conference Call 4Q 2013 Presentation)

High dividend yields and low entry multiples

Seadrill currently trades at the largest forward earnings multiple compared to other firms in the offshore drilling sector: 10.43. Transocean trades at only 8.35x earnings while Noble is the cheapest company in the peer group with a forward P/E ratio of 6.78 (which is equivalent to a whopping earnings yield of 14.7%).

(Source: Achilles Research, Finviz.com)

The decline in equity valuations also led to an increase in yields that investors can enjoy -- considering, of course, no material changes are made to the distribution policies of such companies. Seadrill presently pays investors $0.98 quarterly which translates into a distribution yield of 10.61% -- by far the highest yield in the sector. With that high a yield, Seadrill might also be an interesting alternative for income-hungry MLP investors who usually pursue high-yield investments such as Kinder Morgan Energy Partners (KMP) or BreitBurn Energy Partners (BBEP).

(Source: Achilles Research, Finviz.com)

With a P/E ratio of 10.43 Seadrill is the most expensive company in the peer group, but also offers investors the largest dividend yield of 10.61%. Seadrill currently trades at a 92.91% premium to the peer group average dividend yield of 5.50%.

(Source: Achilles Research, Finviz.com)

Conclusion

I still think that Seadrill is an interesting alternative to other high-yield investments in the oil- and gas midstream business as well as the real estate investment trust sector. While the company itself is cautious with respect to future growth in the offshore drilling market, it is also noteworthy that the company has one of the most modern fleets in operation and also posts consistently high utilization rates (Seadrill's fourth quarter 2013 ultra-deepwater economic utilization rate stood at 94%).

I also believe oil- and gas majors will ramp up spending on new exploration projects as they face ongoing pressure to add to their reserves and have a strong interest in developing conventional and unconventional projects both onshore and offshore. Long-term BUY on Seadrill's historical EBITDA performance, high utilization rates, fleet standard, a low earnings valuation and a double-digit dividend yield.

Source: Seadrill: A 10% High-Yield Alternative To REITs And MLPs

Disclosure: I am long KMP, BBEP, SDRL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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