The Safety Net: Seadrill CEO – You Lie!

Marc Lichtenfeld By Marc Lichtenfeld
Chief Income Strategist, The Oxford Club

Safety Net

This week’s Safety Net is a postmortem on Seadrill Ltd. (NYSE: SDRL).

When I saw Seadrill’s announcement last week that it is suspending its dividend, my reaction was similar to that of Rep. Joe Wilson, who infamously yelled, “You lie!” at President Obama during the president’s speech to a joint session of Congress in 2009.

You see, Seadrill’s management had previously stated that the dividend was safe for another year.

The company is one of the most requested stocks in the Safety Net, thanks to its formerly sky-high dividend yield.

In September, I downgraded its safety rating to a “B.”

I mentioned that I had grown concerned that cash flow no longer covered the dividend. In the first six months of the year, cash flow from operations was $881 million. During the same period, it had paid out $925 million in dividends.

That compared with the year before when, although cash flow was just $671 million, the company paid out only $407 million in dividends. So cash flow more than covered the dividend in 2013.

My downgrade came before oil prices plunged and demand for rigs dried up. But still, the cash flow looked strong enough to support the dividend in the near term, and in August management emphasized that the dividend was safe for at least another year.

On the second quarter earnings conference call on August 27, CEO Per Wullf stated, “We also have [the] strongest financial position in our history and have decided to maintain the dividend of $1 per share. We expect to be able to support this dividend level for [the] foreseeable future.”

He added, “The expected growth strategy, roughly $20 billion of order backlog and continued access to capital market makes the Board highly confident in the company’s ability to support the dividend well into 2016” (emphasis added).

Seconds later, Wullf referred to a newly signed contract, saying it adds to and secures the dividend going forward.

CEOs rarely stick their necks out to say the dividend is safe and then reverse course shortly after. Even a 50% haircut to the dividend would have been surprising given the CEO’s comments three months ago. Suspending it altogether is shocking.

Although I’m admittedly surprised that the dividend was suspended, it reinforces what I’ve said many times in this column – Wall Street isn’t in the habit of giving away money. If a stock has a very high yield, it means there is more risk. It doesn’t mean that a dividend cut is imminent, but investors are being compensated to take on additional risk.

It also teaches us a valuable lesson. As President Ronald Reagan famously said, “Trust but verify.” The next time a CEO says something as fact, remember the Seadrill example.

Management can say whatever it wants, but the numbers need to make sense. In this case, the numbers were deteriorating, which put us on our guard. Whether business fell off a cliff or management was not being truthful a few months ago and had little room for error hasn’t been determined yet.

What we do know is that the CEO of a publicly traded company assured investors that its dividend was safe “well into 2016.” Ninety days later, the same executive eliminated the dividend.

While oil prices did plunge, no doubt significantly affecting the business, it’s hard to imagine that things changed so drastically in just three months that Seadrill could no longer support any dividend.

I shouldn’t have put so much faith in the CEO’s words. Normally, I don’t. But dividends are usually sacrosanct. Any worsening of dividend policy usually results in a big sell-off in stock price. A dividend usually is safe when the CEO says it is.

But with the Seadrill story fresh in my memory, CEOs’ words will carry far less weight than they used to.

We’ll get back to analyzing the dividend safety of your stocks next week. Leave the ticker symbol of the stock whose dividend safety you’d like me to look into in the comments section below.