High-Yielding Seadrill Will Sail Through Difficult Waters

NEW YORK (TheStreet) -- Analysts hate Seadrill (SDRL). It has received five downgrades over the last two months. But this does not mean you should sell this high-yielding stock, especially after its late May quarterly results and new deals signed in May and this month.

Seadrill's utilization rates have fallen and it is having a difficult time finding a new contract for one of its newly built drillship. That is because the company is operating in a weak market which is not showing any signs of improvements.

Seadrill's shares have fallen by more than 8% this year and are closed Wednesday at $37.74.

However, the Seadrill's utilization rate is better than most of its peers. More than 70% of its floaters are contracted out through 2015. The company has been growing its backlog by signing multi-year contracts and has forecast improvements in utilization rates.

Moreover, its recent deal with Rosneft can lead towards improvements in backlog and utilization rates.

Seadrill has grown its cash reserves to nearly $2 billion following drop down of its assets to its master limited partnership Seadrill Partners (SDLP). Seadrill is now transferring this cash to its shareholders by increasing its dividend by 2 cents to $1 per share, which translates into a juicy yield of 10.6%.

Last month Seadrill reported its strong first-quarter results. The company's revenue dropped by 3.5% year-over-year to $1.22 billion, but that was largely due to the deconsolidation of its results from those of Seadrill Partners. On a consolidated basis, Seadrill's revenue increased by more than 14% to $1.44 billion.

Seadrill's profits and its cash reserves have improved significantly due to the deconsolidation. The company's net operating income climbed 61.2% from the same quarter last year to $890 million while its cash reserves increased by threefold to $1.9 billion.

On the other hand, Seadrill's utilization rate for floaters fell to 88%, which is the first time in two years that its utilization rate has dropped below 90%.

Floaters are the backbone of Seadrill's operations. The company gets more than 70% of its contract revenues from them. Nearly 90% of the company's total revenue consist of contract revenue.

The drop in rates highlights the weakness in the industry, which, according to analysts, will likely persist for the next couple of years.

The industry will witness an influx of a large number of new builds while the contracts for the units in operation will expire. This was also evident in Seadrill's quarterly results.

Seadrill has 11 floaters and 8 jack-up rigs currently under construction which will be delivered through 2016 while the company has been unable to secure a new contract for its drillship West Tellus. The drillship has been working for Chevron (CVX) but its contract will expire this Saturday.

The demand for floaters can remain weak due to the increase in supply. For this reason, Seadrill is not committing to any additional units, besides the ones currently under construction.

However, Seadrill is still ahead of its competitors such as Ensco (ESV) and Transocean (RIG) in terms of utilization rates.

Furthermore, West Tellus is just one of Seadrill's large fleet of two dozen floaters, which includes drillships and semi-submersibles.

A significant portion of this fleet is contracted out through 2015, which means that the company can easily navigate through this tough business environment.

Seadrill's contract coverage for floaters is 96% for this year, 66% for 2015 and 47% for 2016. This does not include the new five-year $1.1 billion contract for the West Jupiter drillship with Total (TOT). Moreover, Seadrill is also eying the first contract for West Saturn, another new drillship which will be delivered in the third quarter of this year.

By including the contracts for these two drillships, Seadrill's contract coverage climbs to 98% for 2015 and 72% for 2016.

A couple of weeks ago, North Atlantic Drilling (NADL), which is 70% owned by Seadrill, signed an agreement with Russia's Roseneft. The Russian energy behemoth will become one of the biggest shareholders in North Atlantic while Seadrill will remain the biggest stakeholder.

Rosneft will initially start working with nine North Atlantic rigs but the deal can open doors for some big opportunities for North Atlantic and Seadrill in the Russian market. Seadrill's management isn't worried about the ongoing tensions between the U.S. and Russia over the Ukraine crisis.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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