Should You Buy the Seadrill Dip?

Should You Buy the Seadrill Dip?

While mega-cap names like ExxonMobil and Chevron dominate the conversation in the United States energy sector, they might not produce the best returns over the coming years. In fact, if analyst projections hold true, they should produce lackluster results to say the least.

However, that doesn't mean you should avoid the red-hot energy sector just because the mega-caps are stalling. It's actually in their nature to slow in growth as their size increases, otherwise known as the law of diminishing returns. Instead of being frustrated with their poor growth prospects, let it inspire you to find the next generation of outperformers. A recent sell-off in Seadrill could make it a compelling candidate.

Lagging leaders
First, let's touch on the future of ExxonMobil. A meager yield of 2.60% coupled with earnings growth projections for 2014 of just 6.95% is hardly enough to entice an investment. These projections are right in line with past performance where its average five-year earnings-per-share growth is 5.03% and average five-year revenue growth is 4.16%.

Taking a look a Chevron, we find similar conditions. Despite a relatively stronger 3.30% yield, analysts projections of only 4.67% earnings growth in 2014 are hardly exciting.

So the mega-caps aren't producing mega-returns. Don't despair, though, because high yields and double-digit earnings growth are still very possible in the energy sector.

Looking deeper
Take Seadrill for example, where the recent price drop has increased the yield to obscene levels with valuations reflecting bargain prices.

Aside from the 9.50% yield and projected 36% year-over-year earnings growth rate, this company is experiencing a significant backlog. Its third-quarter report noted that the "total order backlog as of November 22 is $19.5 billion (and it) is likely that order backlog will continue to build during the next quarters." The report further supported strong future prospects: "The fundamental outlook for the offshore drilling industry remains firm. Exploration and production companies continue to view deep and ultra-deepwater acreage as attractive areas to invest capital."

Demand remains high with three out of the 21 rigs still under construction, having already entered into long-term contracts with customers prior to completion. This year, Seadrill has taken delivery and financed a total of 13 rigs and expects to take delivery of seven in 2014, 11 in 2015, and three in 2016. By the end of this four-year expansion, Seadrill would have roughly doubled the size of its fleet.

Seadrill experienced a 10% drop following a miss in earnings, posting a $0.60 gain when the Street was expecting $0.68. However, this was still up from $0.40 the year earlier. That's a 50% year-over-year increase in earnings, with the stock up only 8% over that same period.

Foolish last thoughts
While names like ExxonMobil and Chevron make for a safe investment, they aren't always the most profitable. Occasionally, an unjustified downturn takes a stock with exceptional growth potential into bargain territory, and that's when value-oriented investors should strike to maximize purchasing power. For those who are able to tolerate a bit of volatility, buying Seadrill during this dip could mean outsized returns down the line.

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James Catlin has no position in any stocks mentioned. The Motley Fool recommends Chevron and Seadrill. The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. 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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Originally published