Will 5-year lows prompt drilling stocks to reduce dividends?

By Chris Lau for Kapitall.

Comments from a Seadrill (SDRL) executive, along with rising tensions concerning Russia helped push deep sea drilling stocks toward 3 year lows. Seadrill led the recent decline in the sector. It is now at a 3 year low, along with Ensco plc. (ESV):

Click on the interactive chart to view data over time. 

Seadrill’s CFO, Rune Magnus Lundetrae said that the day rates will not stabilize until after next year. It could get worse for this year and next, due to new vessels entering the market. Weak demand may exasperate day rates for ultra-deepwater rigs. 

Contracting activity is also volatile at the moment. Oil firms have yet to commit to contracts, adding to the uncertainty. Investors are now pricing in a lighter outlook for the drillers. Seadrill’s stock now offers a dividend yielding 13 percent (its dividend is $4 per share annually), while Ensco’s stock yields 5.94 percent.

Speculation is rising that Seadrill could cut its dividend. Even if that were the case, the stock is down sharply from a recent high of $39 a share, recently closing at $30.87.

Uncertainties lurk

There are two big unknowns for investors. For one, oil prices are at lows not seen since February, but with winter approaching, that trend could reverse. Secondly, rig rates are falling, but are volatile. Exploration activity could improve, which will mean better day rates for Seadrill.

Seadrill has a high level of debt, which means more risk due to leverage, should rig rates fall. Conversely, investors looking for less risky plays could also consider Ensco.

The firm operates at a lower leverage, and took write-downs. It anticipates lower cash flows in the coming quarters. At a dividend yield of 5.78 percent, Noble Corp (NE) is another option. The firm recently finalized a contract, but at day rates of $317,000/day.

Still, the company has other rigs under contract that bring in a lot more revenue. The fall in its stock price lowers the risk for investors should rates fall further.

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