Seadrill (SDLP) reported its fourth quarter results on Feb. 25, 2014, and the stock exerienced a knee-jerk reaction with a 6.2% correction. On looking relatively medium-term, Seadrill has corrected by nearly 26% from its all-time highs of $48. The stock now offers an attractive dividend yield of 10.3%. This article will discuss the reasons for believing that the high dividends will sustain and Seadrill is a value pick at these levels.
As the stock price will discount the future, the first thing to evaluate will be the company’s revenue visibility. As of fourth quarter 2013, Seadrill had a contract backlog of $20.2 billion, which gives the company a four-year revenue visibility based on 2013 revenue of $5.2 billion.
For 2014, the current contracted status is 96% for floaters and 80% for jack-ups. There is therefore no immediate revenue downside threat. What is also important to mention from a revenue perspective is that day rates have largely remained stable even when there are no immediate prospects of higher day rates in the industry.
Most recently, Total S.A. exercised its option with Seadrill Partners for contract extension for West Capella. The day rate increased from $580,000 per day to $627,500 per day. Therefore, day rates can be expected to remain strong in the foreseeable future.
In terms of revenue growth, it is also worth mentioning that Seadrill expects capital expenditure for 2014 to be nearly $3.5 billion. Going forward, the capital expenditure will translate into incremental revenue growth.
For Seadrill, it is important to look at the debt and debt servicing capability of the company. For the year ended 2013, Seadrill had a total debt of $13.5 billion with an interest outflow of $336 million during the year.
While the debt levels are high, the debt servicing position is comfortable. This can be backed by two numbers – (1) EBITDA interest coverage of 8.2 for 2013 and (2) operating cash flow to interest coverage of 5.0.
The point here is that debt servicing is not a concern as the company has sufficiently positive operating cash flows. In addition to strong cash flows, Seadrill also has cash and cash equivalents to the extent of $2.2 billion. This includes $744 million in cash and $1.4 billion in financial investments.
Seadrill paid a total dividend of $3.72 per share in 2013. The dividend payout is also likely to sustain and grow as a strong contract backlog of $20.2 billion, which translates into higher cash flows.
On the valuation front, Seadrill is currently trading at an EV/EBITDA multiple of 11 based on 2013 EBITDA. This is at a premium to competitors such as Transocean (RIG) with an EV/EBITDA of 8.06, Ensco (ESV) with an EV/EBITDA of 7.05. Seadrill, however, deserves the premium based on the fact that it possesses a relatively younger fleet.
In conclusion, Seadrill has a strong revenue and cash flow visibility in the coming years. At the current stock price, a dividend yield of 10% is sustainable. Further, as revenue and cash flows grow, stock upside is imminent. Current levels therefore present an attractive buy opportunity.