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Tuesday, October 7, 2014

Recent Buy: SDRL

Oct 6, 2014: Bought 100 shares of SDRL at $25.00 per share.

Established in 2005 as a Bermuda-based company, Seadrill Limited (SDRL) is an offshore deepwater drilling contractor providing worldwide services to the oil and gas industry. The company operates an extensive fleet comprising of drill ships, jack-up rigs, semi-submersible rigs and tender rigs for operations in shallow to ultra-deepwater areas and harsh and benign environments.

In April this year, I bought 72 shares of SDRL at $34.91 per share, so with this buy I'm averaging down to a per share price of $29.15. Yield on Cost (YoC) for this buy is 16%. As I remarked when I bought SDRL in April, the stock is one of my riskier buys, given its relatively short dividend history and erratic earnings history.

SDRL's stock price has tumbled from a 52 week high of $47.28 to around $25.00, a severe drop of nearly 50%. The main reason for the sell-off is a reduction in capital spending by oil producers, compounded by plunging oil prices over the past few months.

Why buy more shares of a riskier stock that is dropping like a fly? Is there still value here? More importantly, how safe is the current dividend? At 16%, the yield seems excessive and unsustainable.

On the other hand, if SDRL finds support and bounces from this level (like it did in 2009) and, somehow, finds a way to continue paying the current dividend, I'll be a very happy dividend growth investor!

Even with the recent drop, SDRL has returned more than 200% since 2005, easily outpacing the S&P 500:

Analysis of SDRL

SDRL ranked fifth in my October's top ten watch list stocks.

My fair value estimate for SDRL is $30.85. SDRL is in oversold territory and I picked up shares at a discount to fair value of about 23%. The following table provides some key statistics for SDRL:

SDRL passes the following of my selection criteria:

  • A streak of at least 5 years of dividend increases (5 years)
  • Dividend yield exceeds 2.75% (16%)
  • Chowder Rule: Dividend yield plus 5-year CAGR exceeds 12% (36%)
  • Price to earnings ratio (P/E) is less than 20 (TTM 2.85x and Forward 7.14x)
  • P/E to annual earnings per share growth (PEG) ratio is less than 2 (0.21)
  • 5-year compound annual growth rate (CAGR) is at least 10% (19.88%)
  • Price discount is at least 5% of fair value estimate (23%)

SDRL falls short of these selection criteria:
  • Earnings per share (EPS) percentage payout is less than 40% (47%)
  • Debt to equity ratio < 50% (130%)
  • Reasonable confidence in continued dividend growth (No)

Based on these statistics, SDRL earns 6 stars out of a possible 7: (******-)

Other ratings for SDRL

 Zacks Rating 3-Hold
 MorningStar Rating (****-)
 The Motley Fool's CAPS Rating (****-)

About the Dividend

The recent price drop has caused SDRL's dividend yield to balloon to 16%. 

Source: dividend.com

There is a possibility that SDRL will cut their dividend, although the company suggests in its second quarter earnings release that the current dividend is sustainable through 2015 and possibly into 2016:
The Board has in connection with the disclosure of second quarter results evaluated the current dividend level. Particular emphasis has been put on financial position, order backlog and future prospects. The Board has resolved to maintain the regular quarterly dividend at US$1.00 per share. The Board had communicated earlier that this dividend level is sustainable until at least the end  of 2015. With the recent contract announcements and the solid execution on the financing side, the Board is pleased to report that we feel increasingly comfortable that this period can be extended well into 2016 without any significant recovery in the market. 

Source: Seadrill Limited

SDRL has set high targets for growth and dividend payments. The company believes "that such high growth can be achieved based on dropdowns from Seadrill's existing fleet and funded by operating cash flow and by accessing the public debt and equity markets."

Concluding Remarks

Many investors are worried that the slowing offshore drilling market will negatively impact SDRL, considering its high debt level, its capital expenditure in building new rigs, and its rather large dividend payments. However, despite the down market, SDRL has managed to secure contracts for 94% of its fleet for 2014 and at increased price levels. The trend in the offshore market is that high-specification rigs (like SDRL's) are taking contracts away from older deepwater and midwater-rated rigs.

Seadrill's founder and major shareholder John Fredriksen recently bought 2 million shares in Seadrill, a bullish sign for investors. Recent articles published on Seeking Alpha (here and here) are also bullish on SDRL. On the other hand, there are bearish viewpoints, too.

SDRL continues to be a risky investment for me, but I'm willing to bet more on a turnaround and more great dividends to come... 

100 shares of SDRL represent $400 of expected annual dividend income, which increases DivGro's projected annual dividend income to $4,992.38.


  1. Nothing like increasing your overall portfolio's output by almost 10% in one fell swoop! I think you are averaging down at a good point. Just this past month my investment club actually picked up some SDRL, and coupled with owning some ESV, I will likely hold off on adding SDRL to my individual portfolio. Best of luck as you look to invest the rest of your cash stash during October.

    1. You're right... I didn't even think about the nearly 10% increase in portfolio output. What I *did* notice is that I reached my goal of $4,800 in projected annual dividend income (in one fell swoop)!

      SDRL may go down a bit more from here, but I'm happy to get in now. If the company ends up cutting their dividend, say, by 50%, I'll still be earning a very high 7% yield on cost. Also, getting back up to $29.15 (my new break-even) would be easier than my original entry at about $35.

      Thanks for commenting!

  2. Thanks for sharing your recent purchase of SDRL. You make a compelling case for this stock. Clearly, falling share price has gotten the attention of many DGI bloggers as the yield for the stock is heading to the moon. Yes it's risky and yes the dividend can be questioned but for those willing to go a little "balls out" the payout can be nice. I'm watching this one as well as others I'm sure.

    1. Hi DivHut! I like you're characterization of what I'm doing here... Personally, I like to see one or two of these kinds of holdings in my portfolio. (The rest should be safe and boring...). If I "win" on this one, it will be big. If I "lose" on this one, the loss would not be crippling.


  3. Hi DivGro. Thanks for your update on SDRL. I have been adding to my position but at slightly higher levels around 27. It is riskier because of their debt, but I think they will manage. If it breaks lower I may do one more buy, but for now I am fine holding SDRL and see how this thing plays out over the next couple years.

    1. Thanks for stopping by MrStockFox -- agreed this is a risky buy, but I feel we're really oversold here and there's a good chance of a bounce. Of course, as DG investors, we're more interested in the long term and what SDRL does with their dividends. Good luck!

  4. Smart move averaging down; that's what I did with KMB. You know, I've seen SDRL being purchased a lot recently, but it's never sat well with me. Mostly because of that debt level and scarily-high dividend. But I did notice it's on David Fish's list, so I think it's time I really sit down and analyze the company and see if my fears are founded. Hope it treats you well though!

    1. Hi DividendDeveloper -- thanks for the well wishes (I may need it!). Yes, SDRL is certainly my riskiest holding in DivGro. I'm OK with that, though, given the potential reward as represented by the "scarily-high" dividend. Of course, I wouldn't want too many SDRL's in my portfolio, nor would I want a SDRL in a portfolio containing only 4 holdings.


  5. DivGro,
    I am hoping to average down as well. I was hoping to get in on a 22/share price point but who knows if they will go that low. I think you will be happy to see those dividends come in. The risk is definitely compensated with that dividend. Good luck!

    1. I think its a good spot to average down. The share price may go down further, giving you a better price point, but it may go up as well. I didn't want to take that chance and I'm happy with getting in at $25. Good luck!

  6. Nice job of averaging down. I've been doing a lot of that with ESV lately. They are in the same situation. I'm thinking of adding some SDRL just to balance out the ESV position I have. I love that they have the newest fleet but it's the debt load that scares me a little. As you mention though, even cutting the dividend by 50% still gives a solid yield. Good luck with this purchase.

    1. Thanks! You're right, the debt load is scary. Hopefully SDRL can leverage their new fleet to secure more and higher paying contracts in the current tough environment and balance out their debt commitments.

      As mentioned elsewhere, this is a risky investment and I'm hoping for a few of these higher yielding dividend checks before a dividend cut. We shall see how this one goes...

  7. I'm curious how you come up with the number of shares to buy?

    1. I buy in chunks of $2,500 -- SDRL happened to be at $25 when I bought it.

      Why $2,500? I like (approximately) equal sized investments and I like to keep the commission (as a percentage) as low as possible.

  8. Ferdi,

    I admire your guts! :)

    It's not an investment I could go after, but I wish you much luck. Even if the dividend is cut, which it may, it's still a solid yield. But that's a bit of a misnomer, because the share price has taken such a hit. I remember that line of thinking being popular regarding Exelon a while back. The yield was buoyed even after the dividend cut, but only because the share price had already come way down.

    Are you not concerned at all with the free cash flow situation? I think that would actually be my biggest problem with the company. They've had really bad FCF metrics over the last five years, even with high oil prices. It would thus make sense that they'll be in trouble with falling oil prices and reduced capital expenditures by some of their customers.

    But I do hope it works out for you. If they're able to keep paying that hefty dividend you'll do quite well, and get your capital returned to you in a pretty quick fashion.

    Best wishes!

    1. Hi Jason -- thanks for visiting!

      No guts, no glory, right? Or maybe this one will cost me dearly in the long run...

      I don't quite follow you on the yield issue, unless you think the share price is going to drop significantly more from the $23 level. My assumption is SDRL is significantly oversold and should return to about $30 in due course. If that happens, I'll have a slight capital gain and the benefit of a 13+% yield as long as SDRL maintains their current dividend. If the dividend is cut 50%, that benefit would drop to 6.5+%, which still is a solid dividend. Of course, there are worse worst-case scenarios...

      The FCF situation is indeed a big concern. It looks like SDLR is maneuvering to delay some of its capex commitments to 2016. It is continuing to leverage capital through MLP Seadrill Partners (SDLP) and North Atlantic Drilling (NYSE:NADL), but those wells may be drying up, so to speak... Dropping oil prices, reduced capex spending by customers, and competition from on-shore sources are additional concerns.

      On the positive side, SDRL has newer, more cost-effective rigs than its competitors and should be able to secure contracts in a more competitive environment. The company is aggressive with its dividend payment program and it looks like the current dividend is sustainable through the end of 2015. Assuming they don't cut their dividend altogether, I should be fine with this one in the long run.

      As I point out in my article, this is a risky investment. I certainly wouldn't entertain the idea of having many SDRLs in my portfolio, but one or two high risk/high reward holdings in a portfolio of 30+ stocks will keep things interesting.

      Thanks for your comment!

      Take care!

    2. Ferdi,

      Tough day for SDRL. I imagined they were going to have a problem with that dividend seeing as how they were bleeding cash.

      The misnomer I was mentioning above is when you have a cratering share price propping up yield, except in this case there is no yield.

      Are you planning on continuing to hold? Maybe they'll turn it around?

      Best regards!

    3. Look for my next post on what I'm planning to do. Obviously, the dividend suspension is a surprise. I was mentally prepared for a 50% cut and not for a suspension. Anyway, you (and several others) can now rightly say, "I told you so!" Still, I accept the bad of risk/reward with the good -- when it does pay off.

      Take care!

    4. Hi Ferdi,

      "I told you so!" would be ignorant for us to say. I bought ARCP just before the "scandal". I rather look at it from a risk management portfolio perspective. You've got a great portfolio and it can easily cover the risk which has effectuated now regarding SDRL. I wish you a lot of wisdom and i'm curious if you stick to the fundamental rule of dividend investment. I've decided to take my loss in case ARCP cuts dividend and will then look at it from a "sunk cost" perspective. I might even sell it earlier already, but have not made up my mind yet. I guess i'm waiting for their quarterly results to be published in January.

      Good luck!

    5. Good luck with ARCP -- seems like accounting fraud caused that one to tank. Hopefully, things will be sorted out by January and you won't be face by a similar situation...

  9. Shame on SDRL for misleading investors about that safe dividend. It might be too late to sell, but I look forward to seeing your post on your plan of action. This one could fall to lower teens but should turn around with all the money they will save on paying out that dividend. Its just how many years will it take to recover? Could be a few years, 5 or maybe 10. We just dont know at this point.

    1. You're right -- it could take a very long time to recover. Perhaps I'll a portion and keep the rest as "dead money" for the long (or very long) run...

  10. Interested to see if you are going to hold on this one or buy more. By cutting dividends to 0, it effectively breaks one of us dividend growth investors' criterias.

    1. Yes, strictly speaking, I should sell. The problem is there has been a knee-jerk and somewhat irrational selloff following the dividend suspension announcement. If effect, I'm waiting for a bounce, which, admittedly, may not come soon enough before I lose patience.


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