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The PHLX Oil Service Sector Index (OSX) has been running hard lately, up 7.5% since only April 17. Yet the offshore drilling industry group has missed the boat, as negative headlines, declining contract activity, and a rotation to natural gas have weighed on its performance. As the negative press abates and contract activity begins to see renewed life, is the offshore drilling segment poised for a comeback?
SeaDrill Limited (SDRL) in particular has a trifecta of advantages:
- a strong dividend with real room for expansion through FY13 and FY14,
- committed insider buying, and
- a recent technical breakout of a downtrending channel.
Combined, these factors point to a profitable short term and long term future for its investors.
SDRL has the most modern fleet of deep-sea drillers in the industry. It provides offshore drilling services to the oil and gas industry, including drilling, completion, and maintenance of offshore wells. It has a market cap just north of $19B with a P/E of 17.4. And it may be remaking certain aspects of the traditional ultra deep sea drilling industry, starting with its focus on how it returns cash to shareholders.
The SDRL Dividend
Based on P/NAV (Price/Net Asset Value), SDRL trades at a significant premium compared to its peers such as Transocean RDC (RIG), Diamond Offshore Drilling (DO), and Noble Corp. (NE). NAV is a key metric when evaluating asset-heavy oil and gas companies, since the vast majority of their value lies in the producing or future producing assets they own. However, NAV – and hence the P/NAV ratio – is more relevant to companies that do not pay a substantial dividend.
SDRL, on the other hand, has a shareholder-friendly dividend policy. Therefore, the stock will trade more in line with market demand for yield rather than simply the aftermarket value for deep sea rigs. Furthermore, because SDRL operates the most modern fleet of rigs, it commands a higher return profile on its assets than its peers.
SDRL currently pays $3.36 per share – a yield of 8.4%. In fact, SDRL’s yield in the post-Macondo (Deepwater Horizon spill) period has averaged near 8.5%. While the yield has fluctuated between a low of 7% and a high of 11%, this degree of consistency during a challenging period for offshore drillers inspires confidence for investors seeking a reliable source of income.
As depicted below, SDRL has an overhead resistance near $42 established Feb. 29, 2012 when Hemen Holding Limited, SDRL’s largest shareholder, announced it would sell 24M shares, bringing the stock’s ascent to a halt and marking a rather precipitous top. Although Hemen later repurchased 6M shares in June 2012 to bring their stake back to 25%, the stock has since shown that the $41 – $42 level is a significant resistance level and psychological barrier.
However, if institutional selling served as the catalyst to form resistance, perhaps insider buying will serve as the catalyst to break through it. In its recent 20-F filed on April 30, it was shown that John Fredriksen, Chairman and President of SDRL, and Tor Olav Trøim, a board member, bought 2M and 1M $40 Jan 15 call options respectively at a price of $1.07 on April 18. This bodes well for the upcoming quarterly report on May 28.
SDRL recently broke out of a short term downtrending channel – while also conforming to a longer term uptrending trading pattern.
First, the breakout of the short term downtrending channel: largely bucking the trend of the S&P since November of last year, SDRL’s performance struggled, along with other offshore drillers. After repeatedly testing its $42 resistance from August through October 2012, the stock initiated a gradual decline, putting in lower lows throughout.
Click to Enlarge At the end of April the stock appeared to consolidate at the top of this channel but – perhaps prompted in part by the 20-F filing on April 30 – suddenly broke out moderately heavy volume, confirming a break of the downtrending channel.
With the run-up from $35 to $41, SDRL potentially could pull back to test the upper bound of the channel – near $38. This would be a best-case scenario for entry given the technical behavior of the stock over the last two weeks. If the stock does not retreat however, it will likely remain below its $42 resistance prior to the earnings announcement on May 28.
Click to Enlarge From a longer perspective, the breakout of this seven-month downtrending channel confirms a multi-year uptrend going back to the crisis lows from 2008-09. Each breakout from the consolidation period has pushed the stock to new highs – with the exception of the most recent phase in which the stock did not break $42. This makes the resistance level a pivotal price: if the stock fails, it could signal a long term reversal of this uptrend; if the stock breaks through – and a break to new highs is the expected outcome of a long term ascending triangle – the stock could see significant upside over the next two to three months.
Recommendation: A break above resistance at $42 is confirmation that the stock is heading much higher and targets should be set near $45-50 per share. We recommend one of two entry opportunities: buy on a break above $41 with a provisional short term exit at resistance at $42 if the stock consolidates. Or buy SDRL following a bounce off support at $37.50 if the stock falls back to the top of the prior channel following earnings.
Options Alternative: Buy to open SDRL July $41 calls prior to earnings for $1.00 per share or less. A break above $42 per share could be used as a trigger to add to the existing position.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.