The day before Thanksgiving, this $10 billion energy company announced the elimination of its dividend. That’s right – the $1.00 quarterly dividend would be discontinued.
In spite of the slow day for the financial markets, investors didn’t waste any time selling the stock. By the end of the session, SeaDrill shares plunged 23%. And just like that, $3 billion of market value evaporated overnight.
As recently as August, the company told investors that the dividend was sustainable until at least 2015. That helped contribute to last week’s shocking news.
SeaDrill had been a favorite of income investors, due to its impressive yield. Throughout 2014, SeaDrill shares have been falling. As the stock price dropped, the yield grew larger and larger. Prior to last week’s news, SeaDrill offered a whopping 19% yield.
Now, you may have never heard of SeaDrill. I certainly hope you don’t own the stock. But SeaDrill offers some important lessons for every investor…especially those who own high yield stocks.
SeaDrill Faces Stiff Headwinds
Let’s start by understanding the company. SeaDrill is an oil services firm that provides offshore drilling services. The company owns a fleet of 69 rigs that are hired by companies producing oil and gas.
In recent years, the company has benefitted from high prices for crude oil. With oil above $90 since mid-2010, it’s been cost effective for energy companies to explore offshore.
Between 2011 and 2013, sales rose 26% and profits soared 89%. That strong performance has allowed SeaDrill to regularly increase its dividend payments. As recently as September, the company was paying a quarterly dividend of $1.00.
But with crude oil falling below $70 per barrel, SeaDrill’s business is facing stiff headwinds. That’s because big oil companies, including Chevron (NYSE: CVX) and ExxonMobil (NYSE: XOM), are cutting back on their exploration activities. With less demand for rigs, SeaDrill is forced to lower their rates.
When the company reported earnings last week, there were some red flags. The highlight was a 40% drop in profits. In the same news release, the company announced the elimination of the dividend.
To put it simply, SeaDrill is a casualty of falling oil prices. Lower crude oil prices help the average consumer. But for companies in the oil services sector, falling prices have a real negative impact.
Lessons from This Dividend Bust
The biggest lesson from SeaDrill is simple: don’t chase high yields.
Low interest rates are forcing many conservative investors – including retirees – to invest in dividend stocks. The primary attraction of these stocks is the dividend payments.
All things being equal, a higher dividend is better than a lower dividend. But far too often, yields of greater than 10% or 12% are a sign of a risky dividend.
As is often the case, SeaDrill’s high yield was a result of its falling share price. Investors seeking stocks with the highest yields will likely discover companies like SeaDrill.
A cursory review shows a growing company whose shares are temporarily out of favor. But a deeper dive reveals serious industry challenges and a deeply indebted company with an unsustainable dividend.
If the dividend yield seems too good to be true, it probably is. SeaDrill isn’t the only energy stock cutting its dividend. Investors should expect more dividend cuts in the coming months.
This article is brought to you courtesy of Ian Wyatt from Wyatt Investment Research.