Seadrill: 'Stock of the Month' pick

by Timothy Lutts, editor Cabot Stock of the Month

It’s no secret that oil prices have collapsed over the past year, thanks to both the global economic slowdown and increased production of natural gas.

As a result, most energy stocks have had a rough time. We think Seadrill (SDRL) presents an excellent opportunity to get on board a top quality company while it’s reasonably priced, and before it breaks out to new highs.

The stock was originally recommended by Lou Gagliardi, editor of our Cabot Global Energy Investor, who’s responsible for most of the industry intelligence below.

It’s a simple fact that the world keeps using more energy. Sure, recent global economic diffculties have slowed the rate of growth, but long-term trends are quite clear; since 2001, global oil demand has grown by 1.4% per year while supply has grown by only 1%!

The main reason for the disparity is that most of the world’s traditional oil basins are plagued by declining flows. A secondary reason is that drilling activity has not kept up. That means more drilling, and that means more work for Seadrill.

The company, which has headquarters in Norway but is legally based in Bermuda, is the largest supplier of offshore drilling rigs in the world, bringing in $4.1 billion in revenues over the past year from its fleet of 66 units.

The company has grown revenues every year since it was founded in 2005 and there’s no reason to expect that to change. In fact, the company recently announced a contract with a major oil company for three offshore rigs in the Gulf of Mexico.

Two of these rigs are brand new ultra-deepwater drillships, to be delivered in 2013, while one is an existing rig. The $4 billion contract runs for 19 rig years, which works out to approximately $576,800 per day per rig.

This is one of the largest contracts Seadrill has ever received, and there’s no doubt one factor in the deal was the youthfulness of Seadrill’s fleet; it’s the youngest in the industry and thus the best equipped to comply with increasingly strict safety regulations (not to mention, generally more effi cient, too).

In fact, compared to its rivals (Transocean, Noble and Ocean Rig), Seadrill’s fleet is not only younger, it’s also geared more toward ultra-deep drilling, where rates are higher and potential payoffs for the explorers are bigger,too.

Yet Lou points out that SDRL trades at a lower multiple than its peers as measured by both market cap and enterprise value to EBITDA. Further, in 2010 and 2011, Seadrill generated higher gross, operating and EBITDA margins than its peers.

Seadrill pays a very generous dividend yield of 8.3% (82 cents per share, per quarter), and while debt is high at 151% of equity, that’s not unusual for the industry, and it’s not a problem as long as rigs stay booked.

Second-quarter earnings will be announced sometime in mid-August, but more important than the numbers will be management’s perspective of the future, and any tidbits about future business and the dividend.

As for the stock, it’s been a “market performer” over the past two years, but the recent action — big upside volume on the new contract announcement — tells us buyers are ready and willing to send this stock higher.

The stock’s March high was 42, and we think buying now will ensure a nice profit when the breakout to new highs comes. Buy.

Learn more about this financial newsletter at Timothy Lutts' Cabot Stock of the Month.

Related articles:

• Atwood Oceanics: Ultra-deepwater gains
• National-Oilwell: Compelling metrics
• Energy Partners: Shallow water, deep profits