Deepwater Drilling's Hot Streak Continues

The ultra-deepwater drilling market is still running at full steam, and Seadrill (NYS: SDRL) is experiencing very strong results because of it. Dayrates for ultra-deepwater rigs are near their 2008 highs, back when oil was near $140 per barrel, and demand for rigs is expanding around the world. This has driven not only Seadrill, but also Transocean (NYS: RIG) , Noble (NYS: NE) , and Ocean Rig (NAS: ORIG) , to expand quickly into this segment.

In the second quarter of 2012, Seadrill's revenue rose 7% to $1.12 billion, operating profit grew 6% to $483 million, and net income was $554 million, or $1.12 per share. The floaters market drove results, which shouldn't surprise anyone, and there's no end in sight to demand. The company's current semi-submersibles and drillships are booked through 2013, with three extending beyond 2016. There are also six newbuild drillships on order and two more semi-submersibles that will be delivered early in 2015. This should secure the company's future, as highlighted by $15.5 billion in backlog for floaters alone.

Management also pointed out that 70% of the ultra-deepwater fleet is doing exploratory drilling, indicating that there should be strong demand as drilling continues.

The shallow-water jack-up markets are starting to stabilize, but they're a footnote to the explosive growth in ultra-deepwater for the industry. Hercules Offshore (NAS: HERO) highlights just how poor that market still is, posting losses while those focusing on deepwater are raking in money hand over fist.

My one problem with Seadrill is the leverage management seems to think is absolutely necessary on the balance sheet. Despite generating $482 million from operating activities, management didn't put money away for newbuilds or significantly pay down $10.6 billion in long-term debt -- it decided to increase the dividend two cents to $0.84 per share. That will drain about $468 million from the coffers that could have been used to reduce leverage.

Paying a hefty dividend is fine, and it's one of the reasons I own the stock, but raising the dividend isn't necessary when cash is being drained by investment and newbuilds still need to be paid for.

If oil stays near $100 per barrel and interest rates remain low, the dividend shouldn't be a problem, but investors should keep an eye on those two variables over the next two years. And this won't be the only company leveraging high oil prices. Our analysts have identified three more, highlighted in our free report.

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