This article was originally published by TheStreet on November 1, 2014. Seadrill subsequently suspended its dividends less than four weeks later after the publication of this story.
By Sarfaraz A. Khan
NEW YORK (TheStreet) -- Seadrill (SDRL) , one of the leading providers of drilling rigs to oil and gas producers for offshore projects, offers a juicy yield of more than 17%. But this might not be sustainable.
In an email interview with TheStreet, Longdley Zephirin, principal and analyst at the research company Zephirin Group said that for Seadrill, the chances of a dividend cut in the near future are "high; however, the chance of the company skipping a quarterly dividend payment is even higher."
Lately, Seadrill's stock has come under pressure due to the weakness in commodity prices, Zephirin wrote. Seadrill's shares have dropped by 40% over the last two months amid a 13% drop in WTI oil futures to nearly $80 a barrel. Overall, the shares have fallen by 44% for the year to date, closing Friday at $23.
The weakness in crude prices is already prompting oil and gas companies to reduce their capital expenditure budgets for the next year, Zephirin explained. This could endanger growth in drilling activity, impacting the performance of offshore drillers like Seadrill, Transocean (RIG) , Ensco (ESV) and Diamond Offshore (DO) .
However, the lower prices will still support the existing levels of offshore drilling activity, said Deutsche Bank's analyst Mike Urban in Oct. 14 research report emailed to TheStreet.
The oil prices pose a new challenge to Seadrill, already struggling with overcapacity in the offshore drilling industry, Zephirin said. According to one estimate, the day rates for deepwater rigs were already down by between 23% and 42% this year from their peak levels in 2013, partly due to excess supply of rigs.
Further, Zephirin predicted the incoming newly built ultra-deep-water floaters could impact day rates, making things even more difficult for Seadrill.
Floaters are offshore rigs that are anchored to the sea floor and "float" on the surface of the water while drilling at depths of usually less than 7,000 feet, though some floaters, such as Transocean's drillship, have worked at depths of more than 10,000 feet.
Seadrill, however, is optimistic about the future of so-called jack-up rigs. These rigs, unlike floaters, stand firmly on the ocean floor and operate in relatively shallower waters with depths of less than 600 feet.
In a September presentation, the company said that although 139 new jack-up rigs, including 10 from Seadrill, will be added to the market by 2017, an even greater number of rigs will likely retire -- which will ease some of the supply glut from the market.
Deutsche Bank's Urban, however, has said that the retirements will not be enough to offset the unfavorable demand and supply fundamentals. Urban wrote that the relatively stable jack-up rig market is following in the footsteps of the floater market due to the difference in delivery schedule, except that the future of the jack-up market "could actually turn out to be worse."
On a positive note, Seadrill has high-quality assets and nearly 80% of its floaters -- a majority of its existing rig fleet -- are contracted through 2015. Therefore, the company can still ride through this tough environment.
However, Urban, who has a hold rating on the stock, has said that Seadrill faces a risk from prolonged weakness in the market due, in part, to its big pile of debt that exceed its market cap by $2 billion.
The company's debt-to-equity ratio, often used to measure leverage, is around twice as high as its biggest competitors such as Transocean, Noble Corp. (NE) , Ensco and Diamond Offshore.
By press time, Seadrill did not respond to messages from TheStreet requesting comment.
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.
