I recently gave a rather gloomy analysis of embattled oil service stock Transocean (NYSE:RIG), pointing mainly to liability issues and soft oil demand in the near-term. Another similar stock, Seadrill (NYSE:SDRL) has since popped up in my inbox — and the company has essentially the same story. SeaDrill is an international offshore drilling contractor. So is Transocean.
But the difference is the dividend. Seadrill currently has a 7.8% yield based on the last four quarterly paydays. Transocean now pays zip.
So does this yield make SDRL a better buy? My short answer: Yes — but know that both the share price and dividend payouts are volatile, so you are making an aggressive play in SeaDrill stock despite the yield.
First, let’s rehash the short-term risks for Seadrill:
Energy demand is weak due to global economic troubles (Check out my column “7 Reasons to Stop Trading Until Thanksgiving”for all the gory details.)
Most experts don’t expect oil to break through $100 and stay there through 2013. (Look at U.S. Energy Information Administration forecasts, for one.)
The stock’s revenue and earnings aren’t growing at a particularly scorching rate in the current environment, and the status quo means more of the same. Here’s a nice table of the past few years to show SDRL fundamentals and how they’ve languished:
These are serious problems that could weigh seriously on shares. Of course, Seadrill stock is up over 30% in the last year to basically double the S&P 500. So that’s not to say there isn’t potential, too.
The reason for a lot of the share performance, however, isn’t the balance sheet. As you can see, Seadrill is very much plugging along as usual with little to set off the fireworks about. It’s the dividend driving in investors who are hungry for yield. And based on a share price of around $40, the company has a yield of 7.8% based on the last four payouts and almost 10% if you annualize the last dividend of 97 cents a share.
Therein lies the rub, of course. Can Seadrill maintain these payouts or will they get cut? After all, two years ago it was paying almost 40% smaller dividends.
And if the dividends get cut you can bet shareholders will cut and run too. And since this is an inherently cyclical stock, you have to have a lot of confidence in the business cycle to bet on either SDRL shares or the dividend moving higher.
I happen to like Seadrill as one of the better drillers out there. It has a strong return on equity and higher gross margins than its peers in the drilling contractor space. It doesn’t face liability issues like Transocean and with a nearly $19 billion market cap is significantly larger (and thus more stable) than companies like deep-water driller Pacific Drilling (NYSE:PACD) or shallow water driller Hercules Offshore (NYSE:HERO).
It also has a very reasonable forward P/E just north of 11, even if it’s about 6% away from a new 52-week high.
I think that the short-term challenges are too great, so I’m not buying. But if you want an aggressive investment that could have big potential down the road — or if you’re content treading water for a yield that could hover around 8% if things go well — then SeaDrill is a decent buy.
Just make sure you’re clear that the dividend is volatile and this company is a speculative income play, not a regular payer with a predictable history.
Do you have a stock that’s on your mind? Drop me a line at email@example.com and I’ll take a look at it.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.