This Oil Stock Could Double Your Money Every 2.5 Years

Monday, February 7, 2011 - 9:00am

by Tom Hutchinson

The world is undergoing a frantic search for new sources of oil. The reason is simple: World-wide oil supply is dwindling while demand is soaring.

The planet is estimated to have 1.3 trillion barrels of proven reserves -- only enough for 40 years at current consumption rates. Oil production in the United States has dramatically declined from a peak of 9.5 million barrels a day in 1970 to about 5.3 million in 2009.

Meanwhile, growing industrialization and living standards in emerging markets are bound to increase oil consumption in the years ahead. In fact, ExxonMobil's (NYSE: XOM) Outlook for Energy estimates that global demand for energy will soar 35% from 2005 to 2030.

The "easy oil" is gone. Traditional land-based or easy-to-reach sources of oil continue to deplete at ever-increasing rates. As the planet continues to demand increasingly scarce oil, there is a growing and highly lucrative market to extract oil from the last frontier -- deep under water.

Seadrill Ltd. (NYSE: SDRL) is one of the world's leading offshore-drilling companies. The Bermuda-based company focuses on deep-water drilling, where it operates the second-largest fleet in the world and the most modern in the industry.

In the past five years, while the S&P 500 sputtered with a meager annual return of just 2.5%, Seadrill returned investors an average of 29% a year during the same period. This return dwarfed that of Morningstar's Oil and Gas Equipment services group, which returned less than 6% a year. A 29% return will double your money every two and a half years.
Why the stellar performance? Because this company is on to something…

Deep water is one of the few places on the planet left where oil is still being found. Huge discoveries have recently been made, including off the shore of Brazil. But, while other companies operate drills and platforms, Seadrill has a huge advantage. Its state-of-the-art fleet is brand new. Of Seadrill's 54 units (rigs and platforms), 43 were built after 2000.

Ultra-deep water drilling is a new technology, and the most modern equipment makes a huge difference in terms of safety and efficiency. The Deepwater Horizon oil spill in the Gulf of Mexico last spring highlighted that fact. As drillers seek modern equipment with more predictability and higher safety standards, Seadrill will likely benefit in the long-term. In fact, as of the end of the third quarter of 2010, Seadrill had a 95% utilization rate for floating rigs and 97% for jack-up rigs, among the highest in the industry.

Seadrill has already become a dominant force in the offshore-drilling industry and has shown every intention of becoming even bigger. The company is controlled by Norwegian billionaire and former shipping magnate John Fredriksen, who has earned a reputation for building business empires through shrewd deals and acquisitions. Since its establishment in 2005, Seadrill has acquired seven companies and taken stakes in nine others. EBITDA has grown more than fivefold since 2006.

The company is still growing rapidly. It acquired (through new builds and acquisitions) 15 additional units in the first three quarters of 2010 alone. And, despite a return of more than 60% in the past year, the stock is still relatively cheap, selling at less than 13 times earnings, compared to an industry average of 27.

But the best part is that Seadrill pays a stellar 7.4% dividend yield (at the current quarterly $0.65 rate) compared to just over 1% for the industry. As a Bermuda-based company, is the company pays no withholding tax and dividends qualify for the 15% reduced tax rate.

Action to Take --> Seadrill pays a high dividend and has strong earnings visibility with a contract backlog of $11.8 billion through 2014 (compared to $3.7 billion in trailing 12-month revenue). The company also seems to have a bright future, as demand for deep-water oil drilling is likely to strengthen in the future. The stock is reasonably priced below $40.

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Tom Hutchinson does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.