Seadrill Ltd (SDRL), ENSCO PLC (ESV): Is this Dividend Really as Dangerously High as Many Believe?

Seadrill Ltd (NYSE:SDRL)’s  dividend is one of the most scrutinized in the energy sector. Indeed, with a yield of 9.4%, way above that of similar sized peers ENSCO PLC (NYSE:ESV) and Transocean LTD (NYSE:RIG) , which yield 5.4% and 4.7% respectively, many investors are right to question the sustainability of the payout.

Seadrill Ltd (NYSE:SDRL) is one of the fastest growing offshore drillers, however most of this growth comes through debt-funded acquisitions and new builds. But this poses several questions: Will Seadrill Ltd (NYSE:SDRL) be able to grow without acquisitions? How sustainable is the company’s dividend? And should investors forgo Seadrill Ltd (NYSE:SDRL)’s high dividend for a stronger balance sheet that could be found elsewhere?

Let’s start with the first of these questions: Will Seadrill Ltd (NYSE:SDRL) be able to grow without additional acquisitions? To try to figure this out, I will be looking at return on invested capital. ROIC is a calculation used to assess a company’s efficiency at allocating the capital under its control to profitable investments. ROIC gives a sense of how well a company is using its money to generate returns. Total capital includes long-term debt and common and preferred shares. If we compare this figure across the industry we can see how efficient each company is at turning invested capital into profits.

Seadrill Ltd (NYSE:SDRL)

Crunching numbers
According to Marketwatch.com,, Seadrill Ltd (NYSE:SDRL)’s ROIC for the last twelve months has been 7.4% and Transocean LTD (NYSE:RIG)’s return has been a lowly 3%. However, ENSCO PLC (NYSE:ESV) has retuned an impressive 7.5%. This indicates that ENSCO PLC (NYSE:ESV) is actually achieving a better return for investors based on the capital invested in the business.

These figures also indicate that Seadrill Ltd (NYSE:SDRL)’s earnings growth during the past few years has been mostly down to its frenzied borrowing. What’s more, as ENSCO PLC (NYSE:ESV) has not been borrowing as heavily as Seadrill Ltd (NYSE:SDRL) to finance what we can now call, debt funded expansion, more cash hits ENSCO PLC (NYSE:ESV)’s bottom line. For example, ENSCO PLC (NYSE:ESV)’s net profit margin now stands at 28.3%, above Seardrill’s reported 24.7%.

With over a billion dollars in quarterly revenue, these few percent are costing Seadrill Ltd (NYSE:SDRL) and its investors tens of millions of dollars per quarter.

Digging deeper
This brings us onto the next question: how sustainable is Seadrill Ltd (NYSE:SDRL)’s dividend? To assess this, I want to use the funds from operations metric, which differs from the net operating cash flow metric as it does not include changes to working capital, and I believe that it is a more telling indicator of the company’s ability to fund its dividend.

So how does Seadrill Ltd (NYSE:SDRL) look? Well, during the last twelve months, Seadrill Ltd (NYSE:SDRL) has generated $1.3 billion in cash from operations. However, during the same period the company has paid out $1.4 billion in dividends. This does imply that the company is having to draw cash from other areas aside from the cash generated from operations to pay the dividend .

In comparison, for the same period, ENSCO PLC (NYSE:ESV) generated $1.9 billion in cash from operations, from which it paid out $440 million in dividends. Furthermore, Transocean LTD (NYSE:RIG) generated $2.8 billion from operations during the same period and paid out $1.12 per share in dividends, a total of $404 million.

Rounding up
So, all in all it would appear than not only is  ENSCO PLC (NYSE:ESV) just as efficient as Seadrill Ltd (NYSE:SDRL) with less leverage, but ENSCO PLC (NYSE:ESV) also has a more secure dividend payout. That being said, I’m not saying Seadrill Ltd (NYSE:SDRL)’s dividend is about to be cut, or the company is going to become insolvent anytime soon. However, for investors who are seeking a well-covered dividend payout and a sector leading return-on-invested-capital, ENSCO PLC (NYSE:ESV) may be the better choice over Seadrill Ltd (NYSE:SDRL), especially considering Seadrill Ltd (NYSE:SDRL)’s debt.

 

The article Is this Dividend Really as Dangerously High as Many Believe? originally appeared on Fool.com.

Fool contributor Rupert Hargreaves owns shares in ENSCO PLC (NYSE:ESV). The Motley Fool recommends Seadrill Ltd (NYSE:SDRL). The Motley Fool owns shares of  Seadrill Ltd (NYSE:SDRL) and Transocean LTD (NYSE:RIG).  We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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